Government unemployment insurance funds in states across the country are running low, with several states, including Maryland and Rhode Island, considering either tax increases or federal bailouts to generate additional funding.
Waste and fraud also plague the system. In some states nearly 20 percent of benefit payments are the result of error or fraud. Some economists argue the basic structure of the system is flawed, encouraging employers to lay off employees and discouraging workers from seeking new jobs until their benefits are nearly exhausted.
Unemployment insurance is designed to provide a financial safety net for laid-off workers, and its funding comes from state and federal taxes on employee wages.
The system is problematic for many workers, however. Part-time workers and those who shift jobs frequently receive no benefits despite their tax contribution, and workers who never need to use the unemployment safety net pay into a system for benefits they never receive.
Creating Moral Hazard
Lawrence Brunner, an associate professor of economics at Central Michigan University, argues the current system presents a moral hazard problem. He recommends moving away from it.
“Normal unemployment insurance leads people to stay unemployed longer. This is the moral hazard problem,” Brunner says. “If people were using their own money to finance time out of the job market, they would have much more of an incentive to get retrained and to find new jobs. We would not have to worry about particular individuals or companies trying to milk the system, say by going on temporary layoff and drawing unemployment compensation while waiting to be rehired.”
Eileen Norcross of the Mercatus Center at George Mason University agrees the system poses a moral hazard dilemma. She also argues the waste in many state programs is systemic.
“The current state-local unemployment program is badly structured. States entered into the recession with inadequate levels of funding to pay out benefits, necessitating several federal benefit extensions at the cost of increased indebtedness,” Norcross says. “During periods of recession, the common trust fund managed by states to pay out benefits becomes depleted, forcing states to raise payroll taxes during and after a recession. All workers end up indirectly subsidizing those who experience unemployment, reducing the capacity of individual workers to save.”
Promise of Individual Accounts
Brunner and Norcross both believe the idea of individual unemployment accounts (IUAs) holds promise. IUAs are mandatory, portable individual trusts to which the employer and employee contribute. IUAs provide workers with greater flexibility to invest and save for periods of unemployment and move resources to best fit their own needs.
IUAs exist in several other countries but not in the United States.
“I think the main benefits IUAs would have are their flexibility and reduction of the moral hazard issue,” Brunner says. “[Individuals with IUAs] would have capital to invest in a business, which might be the best thing for them. Or they would be able to finance retraining toward a new field.
“In the past, normal unemployment insurance lasted only six months, although the recent increases have pushed it to much higher levels. This might not be enough time to train for a new field. With an IUA, the person could retrain, and they would have the incentive to use the money wisely since it is their own,” he added.
Working in Latin America, Austria
Individual unemployment accounts that have been implemented in other countries have seen some successes, including several programs in Latin America and Austria.
Norcross cites the success of a Chilean IUA program, where studies showed effectiveness in improving job-seeking incentives.
Chile introduced IUAs in 2002 along with a smaller social insurance program for individuals with insufficient savings and those who exhausted their individual accounts during long spells of unemployment, says Norcross.
Although IUAs provide many benefits for employees, there are some risks involved.
Possible Need for Supplementation
“The main risk that I see with IUAs is what would happen if someone became unemployed but had not built up much of an account,” warns Brunner. “There might need to be a supplemental program for people in this situation.”
Brunner also questions whether IUAs can adequately finance long-term unemployment, though he notes these problems are shared by the current system.
“One could note that the IUA might not be enough to finance a long spell of unemployment, but of course the normal existing program might not deal with this either,” says Brunner. “I believe that if people are using their own funds, there would be a much greater incentive to become employed and acquire necessary job skills, rather than just waiting for benefits to expire.”
A recent study by the Cascade Policy Institute simulating an unemployment account system in Oregon found when optimally designed, IUAs outperformed both self-insurance and unemployment insurance.
The authors, Stéphane Pallage and Christian Zimmermann, concluded IUAs are a viable alternative that should be considered.
“We are fairly confident that an unemployment account system can be a sound alternative to unemployment insurance policies,” wrote Pallage and Zimmerman.
Matthew Glans ([email protected]) is a legislative specialist in financial services for The Heartland Institute.
“Unemployment accounts would be better for most Oregonians than traditional unemployment insurance,” Cascade Policy Institute: http://www.cascadepolicy.org/2010/08/04/unemployment-accounts-a-better-way/