Do Unemployment Insurance Benefits Encourage Reemployment?

Brief Analyses | Economy

No. 812
Tuesday, June 16, 2015
by Jiawen Chen and Pamela Villarreal

During the 2008 Recession, the Emergency Unemployment Compensation (EUC) program provided the long-term unemployed an unprecedented maximum 99 weeks of benefits. Some weeks of extended benefits were available to workers in all states, but workers in the states with the highest unemployment rates received the maximum weeks of benefits.

The Obama administration urged extension of this unprecedented program, but Congress did not reauthorize it, and the benefits ended January 1, 2014.

Since the federal Unemployment Insurance program began in 1935, policymakers have debated whether benefits help or hurt laid off workers in getting back on their feet. There is a cap on the amount of benefits paid, so the income replacement rate is much lower for high earners than low earners. For instance, suppose a laid-off worker earning $600 a week was eligible for unemployment benefits of about $300 per week. Employment would seem to be the preferable option, but an unemployed person who would pay more taxes if he earned $600 a week — and incur expenses associated with work (transportation, child care and so forth) — might prefer the unemployment benefits. Additionally, a new comparable job might pay less than his previous job, so he could be willing to take a pay cut if he can stay home and not look for work.

Evidence in Favor of the Benefits Extension. The President’s Council of Economic Advisers (CEA) and the U.S. Department of Labor (DOL) released a report just before the program ended that made the case for extending EUC benefits:

  • The CEA and DOL estimated ending extended unemployment benefits would reduce consumer demand, costing 0.2 to 0.4 percentage points of gross domestic product (GDP).
  • This reduction in GDP would, in turn, cost 240,000 jobs in 2014.
  • Furthermore, the report noted, in 2012, 2.5 million Americans receiving unemployment benefits would otherwise have been in poverty.

The CEA/DOL report concluded that financial support to unemployed workers during their search for a job was beneficial to those with extremely limited incomes, and does not noticeably reduce incentives for them to find jobs.

The CEA/DOL also claimed unemployment benefits support economic growth by compensating for the decline in income due to the recession. According to the Congressional Budget Office (CBO), increased spending on consumer goods and services from extending EUC benefits would raise aggregate demand and lead to a higher GDP and employment, as well as higher government revenues through income, payroll and sales taxes.

However, a Dallas Federal Reserve Bank study cautions that extending unemployment benefits could weaken the effect of Federal Reserve actions to stabilize prices and keep unemployment low by stimulating consumer spending. If workers are potentially exposed to long periods off the job, they may start saving more money when they do work simply to get by when they are unemployed. Such saving almost immediately slows consumer spending and impedes short-term economic growth. Therefore, extending unemployment benefits does not likely contribute to economic growth.

The Disincentives Associated with UI Benefits. Though the recession officially ended in June 2009, the number of people receiving unemployment benefits kept growing, which indicates that extended EUC benefits might have more of a disincentive effect on job-seeking than the CEA/DOL study suggested. In 2014, researchers at the St. Louis Federal Reserve Bank estimated that:

  • If the EUC program had expired earlier in 2013, workers with 46 or more weeks of continuous unemployment would be 1.2 to 2.1 percentage points more likely to become reemployed.
  • Workers would increase their search intensity, and more unemployed workers would have find and/or accept jobs.
  • Similarly, the long-term unemployed would be 0.4 to 0.5 percentage points more likely to exit the labor force entirely.

In total, workers would have been 1.7 to 2.5 percentage points less likely to remain unemployed. Similarly, a study from the Dallas Federal Reserve Bank based on Texas employment data showed the length of joblessness is negatively correlated with the likelihood of getting a new job, because long spells of not working lead to considerable skill depreciation, permanently limiting unemployed workers’ productivity.

In a study published by the National Bureau of Economic Research, economists Marcus Hagedorn, Iourii Manovskii and Kurt Mitman found that following the 2013 benefit cut, 1.8 million additional jobs were created in 2014. More than half of these were filled by workers who would have continued to work if unemployment benefits had been reauthorized.

North Carolina’s Success. According to John Hood of the John Locke Foundation, North Carolina resisted the extension of federal unemployment benefits, ending their program on July 1, 2013. Critics of their decision, such as economist Paul Krugman, accused the state of waging a “war on the unemployed.”  However, in the second half of 2013 [see the table]:

  • Payroll jobs in North Carolina rose 1.5 percent, almost twice the national average (0.8 percent).
  • North Carolina’s unemployment dropped 17 percent, compared to the 12 percent average decline nationally.
  • In 2013, the state’s GDP grew 4.2 percent, far exceeding the national average.

Some critics argued North Carolina’s numbers looked better due to the unemployed dropping out of the labor force altogether; but, by May 2014, the state’s labor force participation — the unemployed plus individuals searching for work — had fallen only 0.04 percent, compared to the higher national average of 0.1 percent.

Conclusion. While unemployment benefits provide some much-needed stability for out-of-work individuals, the evidence shows that long-term benefits reduce incentives to work and diminish the skill levels and employability of the unemployed. Despite the arguments that cash benefits increase demand during periods of recession, there is simply no evidence they contribute to economic growth or help the unemployed over extended periods of time.

Jiawen Chen is a research associate and Pamela Villarreal is a senior fellow at the National Center for Policy Analysis.

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