A New Approach to Unemployment?

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On Wednesday, the Senate Committee on Labor, Commerce, and Industry met to discuss a massive debt owed by the state unemployment trust fund to the federal government.

Like many programs imposed on the states by the federal government, unemployment insurance, with its ever-expanding eligibility, has proven to be a fiscal headache. South Carolina has experienced many of the same problems with its unemployment benefit program as other states have endured, having recently expanded eligibility for the program in 2011 and having been dependent on federal assistance to make payments from December 2008 (when the unemployment trust fund became insolvent) to fiscal year 2012. Without federal aid, South Carolina’s unemployment trust fund would have been in the negative $455.3 million as of fiscal year 2012.

The federal government imposes this fiscally burdensome and economically deleterious program on the states through some of the usual methods – taxes and special tax breaks. For example, there is a federal unemployment tax of 6 percent imposed on employers nationwide in order to finance the administration of state workforce agencies and extended unemployment benefits in times of high unemployment. But if states establish unemployment insurance programs that meet federal guidelines (as all states have) and an employer pays his state unemployment insurance taxes to these programs on time, he’ll receive a credit worth up to 5.4 percent, making the effective federal tax rate 0.6 percent. Since state unemployment insurance tax rates are usually lower than the federal 6 percent and unemployment payouts come from state trust funds, states are forced to establish unemployment insurance programs to keep tax rates lower and ensure that citizens are not taxed for a program for which they will see little benefit.

While unemployment insurance was designed to help those who had lost their jobs through no fault of their own remain above water while seeking new employment, it is often actually harming beneficiaries’ long-term prospects. The reason is simple: unemployment benefits incentivize idleness by making periods of unemployment more comfortable and consequently longer. This idleness leads to another negative effect in that workers who have been unemployed for an extended period of time tend to lose or fall behind in valuable skills, making it harder for them to find new employment. The incentives to idleness as well as the negative effects of idleness on future job prospects may in part explain the persistent high unemployment numbers in the U.S., which have coincided with frequent extensions of unemployment benefits enacted by the federal government since June of 2008. Of course any increase in unemployment payroll taxes that frequently follow extended periods of unemployment also increase the cost to business of hiring new employees –making them less likely to do so.

Despite the unintended consequences of the program, the federal government is unlikely to stop pushing some kind of unemployment insurance any time soon. That raises an important question: Are there policies states can enact to achieve the result intended by unemployment benefits without the negative effects of the current program? The Cascade Policy Institute in Oregon, among other groups, has proposed such a policy, and it could be easily implemented in South Carolina.

The policy is based on Chile’s unemployment savings accounts. Both employees and employers contribute to these accounts. The employer contribution is divided between the employee’s individual account and a joint account which helps to subsidize low balance accounts in times of need. When an individual becomes unemployed he can draw 30 to 50 percent of his former wages from his personal account for up to five months.

South Carolina’s government could request a waiver from federal unemployment taxes to implement a similar program (at least a pilot version). A waiver could cover a set number of years to evaluate the results of the program, and then, assuming success, South Carolina could exempt itself from the federal tax. In such a program South Carolina employers would contribute the average state unemployment payroll tax (South Carolina payroll taxes range from a minimum .098 percent to a maximum 8.686 percent with a 2.212 percent rate for new employers) into an employee’s personal unemployment savings account and would contribute the current 0.6 percent federal payroll tax to a joint account from which individuals with low balance personal accounts could draw, as in the Chilean system. Employees would be able to draw a designated percent of their wages from their personal accounts for a set number of months.

Such a program would largely eliminate the incentives for idleness by giving employees ownership of their unemployment savings: people would be much less likely to waste their own savings. Those drawing from the common fund would later repay the common fund out of their personal account once they began to build it back up – creating a disincentive to drawing from the common unemployment fund since that amount would have to be repaid. The unemployment savings accounts could be managed by private investment firms or a state investment commission, and all funds from personal accounts would be accessible to the account’s owner upon retirement.

Removing the incentives to idleness would also help to address the issue of loss of economic productivity generated by the current system.

Ideally, the federal government would not impose an unemployment payroll tax on state employers, and states would be free to determine whether they wanted to operate an unemployment benefit program or not. But that’s not going to happen any time soon. And while these unemployment savings accounts don’t represent the one true solution to fixing a broken unemployment system, they are an improvement over current system.

In the meantime South Carolina, like most states, is largely stuck. For the future, however, policymakers have a choice: the state can either keep paying into a hugely expensive system that encourages unproductive behavior – or explore an alternative system that a) may actually work and b) leaves federal money and meddling altogether out of the picture.

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