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Backgrounder #1506 on Federal Budget

December 4, 2001

What Congress Should Do to Ease the Impact of the Recession on Unemployed Workers

By

As Congress works to design an economic stimulus plan, a key concern is providing relief to unemployed workers and helping them re-enter the work force as quickly as possible. Although there is clearly agreement among Members of Congress and President George W. Bush that something should be done, there is significant disagreement over what course should be taken.

Alternative plans of action include several policy initiatives: the President's Back to Work Relief Plan; the Economic Security and Recovery Act of 2001 (H.R. 3090), passed by the House of Representatives on October 24; and a plan proposed by Senator Max Baucus (D-MT), chairman of the Senate Committee on Finance.1 In addition, Senator John Breaux (D-LA) has proposed a compromise that includes parts of the President's and Senator Baucus's plans.

These alternatives reflect substantial fiscal policy differences. Specifically:

  • The House plan would distribute balances from federal unemployment insurance (UI) trust funds to the states to strengthen their ability to pay UI benefits and provide job-placement assistance. It would appropriately leave specific UI program changes to the discretion of the governors and state legislators.
  • The President's plan would increase spending for National Emergency Grants to states to extend and expand UI benefits. In addition, it would create a temporary extended UI benefit program that would target states with the largest increases in unemployment.2
  • Senator Baucus's plan would create a broad temporary extended UI benefit program for all workers who reach the limit of their regular state UI benefits and would also place three new federal mandates on state UI programs.

Although all of these plans are intended to ease the impact of the recession on the unemployed, none of them will stimulate economic activity. Like all other government spending, UI benefits merely redistribute income from workers and investors to unemployed Americans. While these benefits may provide financial relief to laid-off workers, they will not increase the productive capacity of the economy. Whereas the real catalysts for economic growth are improved incentives to work, save, and invest, studies show that increasing UI benefits actually delays their recipients' return to work.3

Americans prefer paychecks to UI checks, and the best "jobs program" for unemployed workers is to lower taxes on labor and capital and thereby increase job opportunities, investment, and economic growth.

Overview of Unemployment Insurance
Unemployment insurance is designed to replace part of the income lost by individuals with substantial attachment to the labor force who become involuntarily unemployed. Recipients of UI benefits must be able to work, available for work, and actively seeking employment. Currently, 17 states provide a basic weekly benefit equal to 60 percent or more of the average weekly wage in the state.4 The national average weekly benefit is $231 per week, and regular state UI benefits are generally available for up to 26 weeks.5 The UI program also includes an Extended Benefits (EB) program, which extends benefit payments for an additional 13 weeks beyond the regular 26-week benefit period in states where unemployment is high.6

When the UI program was created by Congress in 1935, it was clearly intended to be a federal-state partnership. The Senate Finance Committee's 1935 report emphasized that the legislation "does not set up a federal unemployment compensation program" and that "[e]xcept for a few standards...the states are left free to set up any unemployment compensation system they wish, without dictation from Washington."7 Moreover, the UI system was designed to operate in a competitive market economy and was based on the principle of individual responsibility.8

Under this bifurcated arrangement, the federal government would set broad parameters and oversee state law and operations to ensure compliance and conformity with those parameters. The few existing federal requirements for UI focus on safeguarding unemployment reserves, ensuring efficient administration, and providing program standards with regard to such issues as protecting interstate claimants, coverage of nonprofit organizations and state and local government workers, and extended benefits. The federal regulations do not require a specific level or duration of regular benefits; nor do they mandate eligibility requirements, base periods, or a specific waiting period. Since the inception of the program, these matters have been left to the discretion of the states.

Labor Market Conditions are Weak but not Disastrous
Even before the terrorist attacks on September 11, employment growth had slowed dramatically and unemployment was rising. From January 2001 to August 2001, the average monthly increase in payroll jobs was just 4,000 and the average monthly increase in unemployment was 163,000.9 Since September 11, the number of payroll jobs has declined by an average of 314,000 per month and unemployment has increased by an average of 392,000 per month.

However, most economists expect the recession to be relatively mild. DRI-WEFA, the nation's premier economic forecasting company, predicts the gross domestic product, adjusted for inflation, will decline by just 1 percent during the current downturn (compared to the 1.5 percent decline during the Gulf War and the average decline of 2.2 percent experienced in other recessions).10

Over the past year, the national unemployment rate has risen 1.5 percentage points-- from a 30-year low of 3.9 percent in October 2000 to 5.4 percent in October 2001. Although the national average is still below the 5.8 percent average of the 1990s and the 7.3 percent average of the 1980s, four states and the District of Columbia had unemployment rates over 6.0 percent in October 2001. At the same time, 11 states continued to have unemployment rates below 4.0 percent, and in six states, the unemployment rate actually declined from October 2000 to October 2001.

It should be kept in mind that not all unemployed Americans are involuntarily out of work. In October 2001, 55.8 percent of all unemployed workers (4.4 million) were on temporary layoff or had permanently lost their jobs. Of these laid-off workers, 84 percent (over 3.7 million) were collecting UI benefits. Another 462,000 Americans (5.9 percent of all unemployed workers) had entered the job market for the first time, and 893,000 workers (11.4 percent of all unemployed workers) had voluntarily quit their last job to look for another one. An additional 2.1 million Americans (26.8 percent of all unemployed workers) had re-entered the job market after taking time off for school or to care for their families.

In the week ending November 17, 2001, the total number of persons receiving UI benefits was 4.0 million--up from 2.3 million a year ago. The level of continuing UI claims remains the highest since 1982 and corresponds with the significant increase in mass layoffs throughout the past year. In the first quarter of 2001, nearly 32 percent of UI claimants exhausted their duration period of eligibility for benefits. However, even in periods of low unemployment rates and significant employment growth, it is not unusual for the UI exhaustion rate to be near 30 percent.

In October 2001, the average duration of unemployment was 13 weeks--up from 12.4 weeks a year ago, but just one-half the length of time (26 weeks) that regular state UI benefits are available. One-half of unemployed workers had been without a job for less than eight weeks, and just 11.4 percent (888,000) had been unemployed for 27 weeks or more.

A recent survey by the National Association of Business Economists indicates that most economists expect the unemployment rate will average 5.9 percent in 2002.11 The latest forecast from DRI-WEFA predicts the unemployment rate will rise from 5.7 percent in the fourth quarter of 2001 to 6.4 percent in the third quarter of 2002 but will then decline to 6.1 percent by the end of 2002 and 5.1 percent by the end of 2003.12 This forecast is well below the unemployment rates reached after the 1990-1991 recession (7.8 percent) and the 1981-1982 recession (10.8 percent).

Summary of UI Plans Before Congress
As noted, Congress is debating three different plans to assist unemployed workers during the recession: the Economic Security and Recovery Act of 2001 (H.R. 3090); the President's Back to Work Relief Plan; and a plan proposed by Senator Max Baucus. In addition, Senator John Breaux has proposed a compromise that includes parts of the President's and Senator Baucus's plans.

The House plan would accelerate $9.3 billion in transfers from federal unemployment accounts to state UI accounts. The states would be allowed to spend the funds on UI benefits or to improve unemployment and job-placement services. It is estimated that this plan would increase spending by $4.5 billion over the next five years.13

The President's plan consists of three major elements: a new temporary emergency UI extended benefit program, significant increases in National Emergency Grants for states to extend their UI benefits, and initiatives to encourage individuals to take advantage of existing job-placement assistance and training programs. It is estimated that this plan would increase spending by $9 billion over the next five years.14

Specifically, the President proposes:

  • A new 18-month temporary emergency extended unemployment compensation program for workers who became unemployed after September 11, 2001, in states where the total unemployment rate has increased by 30 percent of the state's average unemployment rate during the three months prior to September 11;
  • The automatic provision of the same extended benefits to states for which the President issued an emergency or major disaster declaration due to the direct impact of the terrorist attacks on September 11;
  • Awarding states $3 billion in National Emergency Grants that governors can use to provide additional weeks of UI to individuals who have exhausted their regular state UI benefit duration and are enrolled in a job-training program;
  • Providing income support payments for individuals who are ineligible for regular state UI benefits but who are able to demonstrate a sufficient involvement in the labor force and are enrolled in a job-training program; and
  • Creating initiatives to encourage Americans to take advantage of existing programs for training, job-search, and placement assistance, to which $6 billion has been allocated.

The Baucus plan consists of four elements: a new broad-based temporary emergency extended UI benefit program; a new federal mandate to increase weekly UI benefit amounts; a federal requirement for states to use an alternative base period for determining UI eligibility; and a federal mandate to make part-time workers eligible for UI benefits. It is estimated that this plan would increase spending by $13.1 billion over the next five years.15

Specifically, the Baucus plan would:

  • Create a new 12-month temporary emergency extended unemployment compensation program for all workers who exhaust the duration of their regular state UI benefits;
  • Mandate an increase in state weekly benefits to workers by an amount equal to the greater of 15 percent of current benefits or $25;
  • Require a new state alternative base period for determining UI eligibility; and
  • Mandate UI eligibility for part-time workers.

What is Good and Bad About the UI Plans
Although proponents of all three plans intend to ease the impact of the economic recession on unemployed workers, there are significant differences between them.

The House Plan
The House plan would distribute the balance of the federal UI trust fund to the states, which could use the funds for UI benefits or to improve job-search and job-placement services to move unemployed workers into new jobs more quickly.

Good Points:
  • It improves an existing program and does not create new programs or mandates.
  • In returning funds back to the states, it uses the same formula for each state that generated the excess federal unemployment tax revenue. It does not redistribute revenue among the states.
  • It gives decision-making authority regarding expanding benefits to governors and state legislators, who are in the best position to design UI and employment service programs to address the unique needs of their respective states.

It is consistent with the original intention of Congress to leave the states free to set up any UI program they wish without dictates from Washington.

Bad Points:
  • Some unintended consequences may arise, given that the federal funds transferred to the states may be used to pay benefits only until March 2003. This could encourage some states to unnecessarily expand UI benefits to ensure that the funds are used before the deadline.

The House plan also has been criticized because the states would have to take legislative action that could delay increasing UI benefits until April 2002 or later. However, the unemployment rate is forecast to peak at 6.4 percent in the third quarter of 2002--precisely at the time when states could use the additional funds to pay for higher levels of regular UI benefits and well after state legislatures convene next year.

The President's Plan
The President's plan would create a new temporary emergency extended UI benefit program, significantly increase funding for National Emergency Grants for states to extend UI benefits, and encourage individuals to take advantage of existing job-placement assistance and training programs.

Good Points:
  • It is flexible and uses an existing program to give governors the grants they need to address the unique needs that layoffs have created in their states and local communities while also providing them with an option of expanding benefits.
  • Although it creates a new extended UI benefit program, it focuses on states with significant increases in unemployment and does not increase the duration of eligibility for unemployment benefits in states that have low unemployment rates.
  • It encourages fuller use of existing programs of training and employment services for dislocated workers, youth, and disadvantaged adults.
Bad Points:
  • It creates a new extended UI benefit program that will likely increase the duration of unemployment for workers in some states.

The President's plan also has been criticized because it does not provide as much relief to unemployed workers as previous temporary extended benefit programs provided during the 1981-1982 and 1990-1991 recessions. However, most economists are forecasting that the current recession will be relatively mild, with the unemployment rate rising to 6.4 percent in the third quarter of 2002 (well below the 7.8 percent unemployment rate experienced during the 1990-1991 recession and the 10.8 percent rate of the 1981-1982 recession). There is no reason to create a broad extended benefit program that would include states that have unemployment rates below 4 percent.

The Baucus Plan
The Baucus plan would create a new broad-based, temporary emergency extended UI benefit program while requiring states to increase weekly UI benefit amounts, use an alternative base period for determining UI eligibility, and make part-time workers eligible for UI benefits.

Good Points:
None

Bad Points:

  • The Baucus plan creates an overly broad extended UI benefit program that would increase the duration of unemployment in all states. Studies indicate that extending UI benefits an additional 13 weeks would actually increase the duration of unemployment from 2.6 weeks to 11.7 weeks.16 It would be counterproductive to extend UI benefits in the 11 states where unemployment rates are below 4 percent. A more effective idea would be to focus on policies that increase the number of job opportunities in all states.
  • The Baucus plan's mandate that states make part-time workers eligible for UI benefits is unnecessary. The minimum work requirements for UI eligibility are already low enough to cover nearly all part-time workers. For example, a part-time minimum-wage worker would have to work only two days per week for six months to qualify for UI benefits in 39 states.17 Employees who worked just three days a week would qualify for UI in all but three states. Moreover, part-time workers in private industry earn an average of $9.41 per hour.18 Working just three days per week for six months at this wage level would qualify a worker for UI benefits in every state.19
  • The Baucus plan's requirement that states increase the amount of UI benefits by 15 percent would also lengthen the duration of unemployment for workers by more than two weeks.20 Moreover, it is not clear that UI benefits need to be increased. The frequently cited wage replacement rate that is published by the U.S. Department of Labor (DoL) is misleading because it compares benefit payments to the wages of all workers.21 A more accurate measure would compare benefit payments to the wages of UI beneficiaries, not all workers.22 Using this gauge, one study found that the actual wage replacement rate in six states averaged a generous 65 percent, not the 39 percent reported by DoL.23 This 65 percent wage replacement rate is well above the 50 percent rate recommended by the Advisory Council on Unemployment Compensation.24

The mandate in the Baucus plan that would require all states to use an alternative base period for determining UI eligibility is contrary to an understanding, universally adopted throughout the 65-year history of the UI program, that the base period eligibility requirement is within the ambit of state authority.25 The base period is not a matter of administrative convenience. It represents the public policy judgment made by the states that UI benefits should be payable only to persons with a demonstrated and continued attachment to the workforce. In 1997, Congress clarified federal law to give states full authority to set base periods.26

What Congress Should Do
Workers always prefer the independence of a paycheck to being dependent on government UI checks. If Members of Congress want the economy to create more jobs and higher wages, they should reduce the taxes on labor and capital. Specifically, Congress should:

  • Accelerate all of the personal income tax rate reductions that were signed into law earlier this year.27 Congress has already agreed to across-the-board tax relief, making debates about "distribution tables" moot.28 Regrettably, however, many of the tax rate reductions are not scheduled to take effect until 2004 and beyond. This means that the pro-growth impact of those changes will not occur until after 2003. If lawmakers want to stimulate additional work, saving, and investment to address today's problems, they should make all tax rate reductions effective immediately.
  • Repeal a little-known temporary payroll surtax under the Federal Unemployment Tax Act (FUTA), which has outlived its purpose.29 Repealing the temporary payroll surtax would reduce the cost of employer-paid mandates by $9.5 billion from fiscal year (FY) 2002 to FY 2006, encourage businesses to keep workers on the job, and remove an obstacle to reviving employment growth--particularly among unskilled low-wage workers.30 The permanent portion of the FUTA tax is more than sufficient to finance the UI system during a recession.31 Even if the surtax is repealed, the permanent part of the FUTA tax would have a surplus of $2.5 billion in FY 2002. Furthermore, eliminating the surtax would not endanger federal UI trust fund balances; its accounts would continue to grow from $44.7 billion in FY 2002 to $55.0 billion in FY 2006--an increase of 23.1 percent.

Ending the temporary payroll surtax would allow workers and employers in South Dakota to keep an additional $26.3 million of their earnings from FY 2002 to FY 2006, which they could spend, save, or invest. In Mississippi, workers and employers would see their payroll taxes cut by $83.2 million during that same period. Workers and employers in Illinois would save $435.4 million in payroll taxes from 2002 to 2006; in Texas, savings would amount to $675.6 million, and in California, they would amount to nearly $1.1 billion.

  • Distribute surplus FUTA tax revenue that has built up unnecessarily in federal UI trust funds back to the states through what are known as Reed Act distributions.32 This would infuse tens to hundreds of millions of dollars into state UI trust funds and significantly improve both the financial condition of those funds and the states' ability to provide UI benefits. It would also enable the states to improve their employment services, helping to move the unemployed back into the workforce as quickly as possible.

From FY 2002 to FY 2006, Reed Act distributions would amount to $20 million for South Dakota, increasing the state's current UI trust fund balance by almost 44 percent. Mississippi's UI trust fund would receive $62 million, increasing that state's already large UI trust fund balance by over 9 percent. Illinois would receive $405 million from 2002 to 2006, a 23.2 percent increase in its current UI trust fund balance; Texas would receive $730.4 million, a 118 percent increase in its trust fund balance; and California would receive $956.5 million, a 17 percent increase in its trust fund balance.

  • Replace depreciation with expensing of business investment.33 Replacing the current depreciation rules with immediate expensing of those investment costs--or at least implementing a significant shift in that direction--would boost capital formation, increase productivity, and raise real wages.
  • Extend refundable tax credits to all unemployed workers to help pay health insurance premiums. The Consolidated Omnibus Budget Reconciliation Act of 1986 (COBRA) requires employers with 20 or more employees to offer continued group coverage to their employees and their dependents after employees are laid off, but it does not require the employer to contribute toward the premium. A federal refundable tax credit would give displaced workers a credit to help them pay premiums for either COBRA or a private replacement coverage alternative. A refundable tax credit should also be available to displaced workers who are not eligible for COBRA coverage.
  • Limit new spending. Every dollar the government spends--whether prudently or foolishly--is a dollar that is diverted from the private sector.34 When government spends money, political factors and bureaucratic inefficiencies often result in the inefficient allocation of funds. Controlling the size of government means that more money is left in the private sector and therefore helps to engender more economic growth. This explains why the U.S. economy has outperformed the economies of welfare states that are burdened by high levels of taxes and spending.
  • Reject the broad expansion of UI extended benefits. Broadly extending UI benefits an additional 13 weeks even in the 11 states with unemployment rates below 4 percent is an irresponsible use of federal taxes and would unnecessarily increase the duration of unemployment in those states. The combination of a 6.5 percent unemployment rate trigger and a 30 percent threshold-increase requirement would focus extended benefits on those states hardest hit by the recession and responsibly offset the work disincentives of extending UI by directing assistance only to areas where there is a clear need.
  • Reject unnecessary and costly federal mandates. Governors and state legislators are in the best position to design UI and employment service programs to address the unique needs of their states effectively. With the exception of implementing a few standards to ensure that the UI program fulfills its intended role, Congress historically has left the states free to set up any unemployment compensation system they wish, without federal mandates. Most part-time workers are eligible for UI benefits, and mandating increases in the benefit amount would lengthen the duration of unemployment. Congress should focus on improving the incentives to work, not on policies that lengthen the period of dependence on government programs.

Conclusion
The current congressional debate regarding assistance to unemployed workers centers on three different proposals: President Bush's Back to Work Relief Plan, the Economic Security and Recovery Act of 2001, and a plan proposed by Senator Max Baucus. Although all three plans are intended to ease the impact of the recession on the unemployed, none of them will stimulate economic activity. Like all other government spending, UI benefits merely redistribute income from workers and investors to unemployed Americans. These benefits may provide financial relief to laid-off workers, but they will not increase the productive capacity of the economy and will not improve incentives to work, save, and invest--the real catalysts for economic growth.

Workers prefer paychecks to UI checks, and the best "jobs program" for unemployed Americans is faster economic growth. Specifically, Congress should accelerate all of the personal income tax rate reductions that were signed into law earlier this year. It should also repeal the temporary surtax under the Federal Unemployment Tax Act, which has outlived its purpose. This would reduce payroll taxes, encourage businesses to keep workers on the job, and remove an obstacle to reviving employment growth.

In addition, surplus FUTA tax revenue that has built up in federal UI trust funds should be returned to the states. This would significantly improve the financial condition of state UI trust funds, strengthening their ability to provide UI benefits and enhance employment services to help move the unemployed into new jobs as quickly as possible.

Congress should also reject costly federal mandates and proposals for the broad expansion of UI extended benefits even to states with low unemployment rates. Governors and state legislators are in the best position to design UI and employment service programs to meet the unique needs of their states, and they should retain their decision-making authority. Congress should focus on improving incentives to work rather than on policies that prolong dependence on government programs.

D. Mark Wilson is a former Research Fellow in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.


1. The President's Back to Work Relief plan has been introduced by Senator George Allen (R-VA) as S. 1532, the Emergency Extended Unemployment Compensation Act of 2001. Senator Baucus's plan, the Economic Recovery and Assistance for American Workers Act of 2001, was approved by the Finance Committee on November, 8, 2001.

2. This would be a new program in addition to the permanent extended benefits program that already exists.

3. Paul T. Decker, "Work Incentives and Disincentives," in Unemployment Insurance in the United States: Analysis of Policy Issues , ed. Christopher J. O'Leary and Stephen A. Wandner (Kalamazoo, Mich.: W. E. Upjohn Institute for Employment Research, 1997), p. 293.

4. Christopher J. O'Leary and Murray A. Rubin, "Adequacy of the Weekly Benefit Amount," in Unemployment Insurance in the United States: Analysis of Policy Issues , p. 174.

5. U.S. Department of Labor, UI Data Summary: 1st Quarter CY 2001, June 2001.

6. The Trade Adjustment Assistance (TAA) Program also provides workers laid off for trade-related reasons an additional 52 weeks of UI benefits beyond the regular 26-week benefit period. In FY 2000, almost 150,000 workers were eligible to receive TAA.

7. Thomas E. West and Gerard Hildebrand, "Federal-State Relations," in Unemployment Insurance in the United States: Analysis of Policy Issues , p. 551.

8. Saul J. Blaustein, Christopher J. O'Leary, and Stephen A. Wandner, "Policy Issues," in Unemployment Insurance in the United States: Analysis of Policy Issues , p. 2.

9. Unless otherwise noted, all of the data in this section are Heritage Foundation calculations based on data from the U.S. Department of Labor, Bureau of Labor Statistics and Employment and Training Administration.

10. Diana I. Gregg, "A Mild Recession Still Best Bet, Economists Tell Housing Conference," Bureau of National Affairs Daily Report for Executives , November 15, 2001, p. A35.

11. "Business Economists See Mild Recession with Modest Turnaround Early Next Year," Bureau of National Affairs Daily Report for Executives , November 15, 2001, p. A43.

12. DRI-WEFA, U.S. Economic Outlook, October 2001.

13. Congressional Budget Office, "Cost Estimate for H.R. 3090 the Economic Security and Recovery Act of 2001," October 16, 2001, available at www.cbo.gov/cost.shtml (November 2001).

14. Heritage Foundation calculation based on U.S. Department of Labor data.

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