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The Individual Asset Account (IAA): Turning Unemployment Insurance (UI) into an Asset
Unemployment Insurance (UI) and personal assets are safety nets; one is built by government and the other by the individual. Both protections are lacking: UI benefits are faulty – they increase temporary lay-offs, and delay re-employment for that minority share of workers who receive benefits, and individuals are not saving enough to help themselves in difficult times.
Cascade is proposing a reform that would improve both safety nets, boosting personal asset development while simultaneously broadening UI’s usefulness and efficiency.
Cascade seeks to initiate a pilot program that would allow employers and workers in Oregon to opt-out of the mandatory UI system and participate in an alternative arrangement of Individual Asset Accounts (IAAs). Employers would direct UI payroll taxes into IAAs for each worker. IAAs could be used for either unemployment insurance benefits or mid-career training, regardless of whether the worker was laid off. At retirement, the account balance would merge with the worker’s IRA, and in the event of a worker’s premature death, the IAA would pass to heirs.
Full implementation of this proposal would effectively kill two birds with one stone: improving the inefficient and ineffective UI system while helping individuals build assets. Since asset building is the key to helping low-income individuals (and everyone else) gain stability and success, this program could have far reaching effects.
Contents:
1. Unemployment Insurance Basics
2. Problems with Unemployment Insurance
a. A Limited Source of Protection
i. Full-time students
ii. Legal foreign workers
iii. Women
b. Workers Pay for Unemployment Insurance
c. Unemployment Insurance is Not Economic Stimulus
d. Unemployment Insurance Discourages Reemployment
e. Unemployment Insurance Increases Lay-offs and Delays Rehiring
f. Saving Needs Saving
g. Putting an End to Waste
3. The Individual Asset Account Solution
a. Some Policy Requirements and Recommendations
b. Significance of Policy Changes
4. Links
5. References
The federal government (through the Social Security Act) compels each state to operate an Unemployment Insurance (UI) system. UI is predominately state-run and thus varies some from state to state. It is funded through payroll taxes, paid by the employer. Of course, as businesses and economists know, ultimately employees fund UI through lower wages.
State payroll taxes pay for the state’s UI program. The tax rate varies among employers, with those who have a history of laying-off workers paying more. In Oregon, the rates vary from year to year. In 2006, employers paid the state an average of 2.26% of the first $29,000 of each employee’s wages – averaging about 1.35% of total wages. This does not include the federal unemployment tax collected by the IRS, typically averaging around .8% of the first $7000 of wages. Some workers are excluded from the UI program and exempt from payroll taxes, including roughly 200,000 self-employed workers and independent contractors in Oregon in 2007.
In limited circumstances, UI benefits serve as a partial income substitute for unemployed workers for up to 26 weeks in Oregon and most other states. Oregon’s UI benefits range between $113 and $482 per week, depending on the prior income of the worker.[1]
When a state enters times of high unemployment, the federal government will typically fund 13 more weeks of unemployment benefits through the federal unemployment taxes. Recently, the struggling economy and rising unemployment rate caused Congress to extend potential protection to up to 20 weeks nationally, and 33 weeks in states with higher unemployment, for a total of up to 59 weeks of benefits in Oregon.[2]
The Employment Department determines eligibility for UI benefits based upon the claimant’s work record for the 12 month period (in quarters) prior to applying for UI benefits. The unemployed worker must have worked in qualified employment for a minimum of 500 hours during the prior 12 month period, or the worker must have earned sufficient wages in qualified employment to apply. Unemployment must have been involuntary and not a result of misconduct. Additionally, recipients must be actively looking for a new job, available for full-time work, and must not turn down offers without good cause.
*Learn more about Oregon UI at Oregon’s Employment Department website
A Limited Source of Protection
UI’s basic requirements typically exclude most unemployed workers from receiving benefits. In Oregon, only about 40% of those unemployed in 2007 lost jobs involuntarily.[3] This means that fewer than 40% of Oregon’s unemployed workers were eligible for UI benefits. While times of severe economic distress yield higher UI eligibility, such low numbers are typical for the modern workforce. In fact, from 1967-2002, according to one study, only about a third of the unemployed received UI benefits nationally, and in Oregon.[4]
Full-time students, many part-time workers and those who shift jobs frequently cannot receive benefits, despite the mandated UI taxes paid on their behalf by their employers. Workers who never need to use the unemployment safety net pay into a system for benefits they will never receive.
Legal foreign workers are deprived of UI benefits though their employers pay into the system regularly. In 2005, 600 Oregon businesses applied for permission to bring nearly 6,000 foreign workers to Oregon on an H-1B visa, a temporary work program for skilled workers. All of their employers pay into the mandatory UI system, but the H-1B workers cannot use it for more than 5 years until and unless they get their “Green Card” (U.S. Permanent Resident Card) approved.
Women, particularly, find themselves excluded from UI coverage. Women have more complicated career patterns than men because they tend to enter and exit the paid workforce and switch from full-time to part-time work, as they raise children or care for other family members. Women frequently leave work voluntarily or are no longer available for full-time work because of family obligations; therefore, in spite of working steadily for years, they lose claim to any benefits. In other words, their employer pays into a system that they will not be able to use.
Workers Pay for Unemployment Insurance
While employers pay the payroll tax for workers, studies have shown that ultimately it is the worker who pays by taking home lower wages.[5]
“In general, a tax on wages lowers the demand for labor. The burden of the tax is divided between workers and employers based on a formula that involves the elasticities of labor supply and demand. The demand for labor is very elastic, meaning that it responds strongly to small changes in wage rates. The supply of labor is relatively inelastic, meaning that a change in the wage rate creates only a very small change in labor supply. In these circumstances, a tax on labor will be mostly borne by workers. This has been confirmed specifically for the UI tax; the average amount of the tax is fully passed on to workers in the form of lower wages. However, the variation in employer tax rates caused by different employers having different experience ratings is not passed on.”[6]
In other words, the higher the payroll tax, the more that an employee loses in wages. This is true except to the extent that an employer’s payroll tax rate is higher than other employers in his industry because of his higher rate of layoffs. Accordingly, when the state increases or expands UI coverage, workers foot the bill.
Unemployment Insurance is Not Economic Stimulus
Contrary to rumors, UI provides little stimulus to the economy.[7] It increases consumption, but it also increases unemployment and decreases private investment. In short, spending money to sustain a person who is not working is not an investment in economic growth. In fact, for every dollar that the federal government spends on UI, GDP expands only around 25 cents.[8] Likewise, increasing state spending on UI does not stimulate the economy.[9] There are other ways to stimulate the economy that would give a considerably higher return. Accordingly, the current system cannot hide behind the guise of stimulus.
Unemployment Insurance Discourages Reemployment
UI discourages unemployed workers from looking for new work. Unemployed workers who receive benefits take more than twice the time to find a job than those who are not eligible to receive benefits.[10] The likelihood of recipients finding a job increases strikingly just before UI benefits are exhausted.[11] Bigger benefits lead to longer terms of unemployment.[12] If employees would search harder, employers could fill positions faster and total unemployment would shrink, causing national productivity and wealth for everyone (including workers) to increase.
While recipients of unemployment benefits are required to be available to work and to actively look for a job, the promise of benefits discourages employees from looking very hard. Ordinary hard-working individuals will find their drive to find a new job diminished when they are receiving more than half their previous income while gaining time to spend with family, pursue hobbies, or to invest in improvements (in themselves or their property).
Some argue that longer unemployment leads to better job matching and higher wages. However, this benefit is limited, and some studies suggest that it is exaggerated or imagined.[13] For example, one study showed that when workers are offered reemployment bonuses, they find jobs faster, at a comparable or slightly higher value to those workers in a control group.[14] In other words, generally, a good job fit and higher wages can be found faster with a higher intensity search. But the longer it takes the unemployed to find a job, the more it costs the system, businesses, and especially workers.
Unemployment Insurance Increases Lay-offs and Delays Rehiring
Unemployment Insurance sometimes encourages employers to lay off workers and to delay rehiring them.[15] Without UI, employers risk losing good employees or not being able to attract good employees when they lay off people. UI protects certain types of employers from the bulk of this risk.
Econometric studies have varied, but the overwhelming conclusion is that UI increases layoffs. One study concluded that layoffs, generally, are 5% higher due to employers abusing UI.[16] Other studies estimated that 20-30% of temporary layoffs were caused by this problem.[17] One study even estimated that in the depths of recession, UI may cause half of all layoffs.[18]
Why does this happen? Because the experience rating does not reflect the cost to the system. The experience rating determines a firm’s payroll tax rate. The rate is adjusted according to how many of a firm’s laid-off workers file claims for benefits: the more workers laid off, the higher the tax rate – but only up to 5.4%. Since experience ratings do not reflect the cost to the unemployment system, some employers lay off workers regularly and systematically, essentially using UI as a subsidy for their employees in an off-season. For example, an employer paying the maximum rate in payroll taxes will not pay more for laying off one more employee.
Without UI, such employers would have to alter business practices to provide year-round labor, or pay their employees more when work is plentiful, in order to attract and retain trained workers. Instead, many employers use UI to subsidize employee pay. These practices cause UI to unfairly prop up certain businesses and industries, at the expense of others’ tax dollars. Making matters worse, UI causes employers to take longer to rehire, causing many employees to stay unemployed longer, enduring without important benefits like health insurance.
Government safety nets also have the unfortunate effect of giving citizens a false sense of security. Many individuals will assume the government will protect them and fail to save as much as they would if the government did not have built in protections. This not only discourages personal responsibility, but it also discourages saving.
Saving money builds assets, which improves individuals’ lives and helps the economy. If people saved more for their own unemployment (through IAAs or own their own) “there would be a greater supply of loanable funds, thus tending to lower interest rates and stimulate capital investments.”[19] But under the current UI system, the funds from unemployment taxes are “‘invested’ by the Treasury in the U.S. government debt obligations, which does little – to put it mildly – to help the economy grow.”[20]
Another point of concern is the waste and fraud plaguing the UI system. In 2007 alone, of the $499 million distributed UI benefits, reportedly $14.9 million constituted overpayment in the form of error or fraud. In some states nearly 20 percent of benefit payments are the result of error or fraud.[21] In Oregon, the rate is more modest (but still troubling) at around 12%, according to the Department of Labor. There was almost $60 million in overpayments in Oregon in 2006, of which, around $42.4 million was not recovered.
The current system provides no incentives to state agencies to reduce administrative costs or fraudulent claims. Part of the separate federal unemployment tax trust fund reimburses state administrative costs and cannot be used to pay benefits; conversely, benefit funds cannot be used for administration. The inflexible wall between the two funds means that a state cannot use benefit funds to pay for administrative initiatives – such as work search assistance – which eventually could save benefit funds. This reduces states’ ability to deliver services more efficiently.
A shift to a system that combines modest government insurance with individual investment-based accounts is one way to remove the work disincentives associated with the present UI system while broadening the pool of eligible recipients.
The Solution: The Individual Asset Account
A solution to both problems is to convert UI into a hybrid of IAAs (Individual Asset Accounts) and a small common-pool fund to subsidize qualified low-balance accounts. IAAs would accumulate tax-free for life and could be used at the discretion of each worker for unemployment insurance or mid-career job training. At retirement, the account’s balance would be deposited into the worker’s IRA, could be turned into an annuity, given as a lump sum transfer to the retiring worker, or passed onto heirs.
The IAA has been inspired by Chile’s innovative UI system of Individual Unemployment Savings Accounts.[22] In the Chilean system, employees pay 0.6% of their wages into the accounts, while employers pay 2.4%, which is split between the worker’s individual account (1.6%) and a joint account to help subsidize low-balance accounts (0.8%). Upon unemployment, workers can draw 30 – 50% of wages, for up to five months. In contrast to the current U.S. system, the worker receives benefits regardless of whether he or she quit or was fired. After all, it is the worker’s own money.
In this proposed IAA system, employers would pay state payroll taxes into the employee’s IAA. Individuals could also voluntarily contribute additional funds to individual IAAs. The federal payroll tax would fund the common fund, as shown in the following figure.
As seen in the figure, the tax rate for employers to pay into the IAA is estimated at 1.6% of wages, while the rate paid to the common fund is estimated at .8% of the first $7,000 of wages. The 1.6% represents the average payroll tax rate paid to the state on wages; .8% is approximately what is paid to the federal government, currently.
In the pilot program, the exact rate of payroll taxes would probably vary from the rate used in the above figure, since rates change depending on the year or employer. In choosing the tax rates used in the pilot project, rates according to experience rating should perhaps be kept to some extent since employees who work for a business that commonly lays-off people need extra protection. The goal is not to increase taxes, but to use current tax dollars to increase private wealth.
Certain basic rules would govern the withdrawal of money from an IAA so that the IAA would not be completely drained simply because it is a personal account. Similar to the current system, the government would limit the size, frequency, and duration of withdrawing benefits from the account. Individuals could always withdraw less money than they are allowed, preserving their savings.
IAAs would be owned by workers and could be managed for them by either private firms (which is how Chile does it) or the Oregon Investment Council, which manages more than $60 billion in public pension funds.
Individuals with insufficient funds in their accounts would be covered for a limited time by the common fund, provided that the individual meet certain eligibility requirements (similar to those in place for the current UI program). Upon receipt of benefits from the common fund, the worker’s IAA could be debited by a corresponding amount. Later, when the worker has a job, he would have to pay back this amount before he would gain a positive balance in his account. A reasonable debt ceiling would be established to give everyone a realistic possibility of accumulating a positive account balance. At retirement or death, the debt would be canceled if the worker’s balance is still negative.
Currently the Oregon UI Trust Fund has an account balance of nearly $2 billion. This money is collected through payroll taxes paid by employers on behalf of close to 1.5 million workers. We propose utilizing part of this revenue to finance the pilot project. It would transition volunteers who meet certain eligibility requirements (including certain unemployment risk factors and belonging to a representative range of pay) from traditional UI coverage into IAAs.
Some Policy Requirements and Recommendations
- Individual Asset Accounts (IAAs) would require a federal waiver so that Oregon employers could “opt out” of the federal UI system and experiment with new policy ideas.
- IAAs should be allowed to be funded by state UI taxes by employers, similar to 401(k) accounts. The employee also can contribute to this account tax-free.
- Employers may get a tax credit for one-time contributions to each IAA.
- Low-income workers should be allowed to use money from this account to start or continue an IDA account.
- This would be a voluntary initiative for employers and employees who want to participate. It would begin as an “optional” pilot project.
Significance of Policy Changes
- Over 1 million Oregonians could participate voluntarily to build their own assets.
- IAAs will encourage low-income workers to think like stakeholders rather than like dependents or victims. They will encourage people to seek and acquire financial knowledge. They will give many low-income workers the opportunity to be treated with respect, like “investors,” by formal financial institutions.
- It would include many other workers who could not participate in the traditional UI system, though their employers were paying into the system for them.
The Unemployment Insurance (UI) system is called an “insurance” program because it deals with the risk of job loss, but this social insurance program differs from private insurance. The UI system is actually an income-transfer program into which employers must pay for their workers, even if most workers are not eligible to receive UI benefits when they become unemployed. People do not have ownership rights to UI benefits, and governments can change the benefit payment schedule or eligibility standards at any time.
If you want to know more about this project, please contact Christina Martin, the director of the Asset Ownership project at 503.242.0900 or Christina@cascadepolicy.org .
Cascade Archives About Unemployment Insurance
Cascade Archives About Asset Ownership Issues
Other articles of special interest:
Unemployment Insurance Savings Accounts and Collective Wage Determination by Laszlo Goerke, November 2007
Unemployment Insurance in a Free Society by William B. Conerly, 2005
Individual Unemployment Accounts by Lawrence Brunner & Stephen M. Colarelli, 2004
Chile’s Unemployment Insurance Model by William B. Conerly, 2003
Unemployment Protection in Chile by Wayne Vroman, Urban Institute, 2003
[1]Oregon Employment Department, About Unemployment Insurance Benefits, www.employment.oregon.gov/EMPLOY/UI/about_benefits.shtml
[2]Unemployment Compensation Extension Act of 2008, H.R. 6867, amending 26 U.S.C. 3304 (110th Congress).
[3]Art Ayle, Understanding Oregon’s Labor Force, http://www.qualityinfo.org/olmisj/ArticleReader?itemid=00005834 March 21, 2008.
[4]Vroman & Woodbury, supra note 1, at table 2.2, and table C.1.
[5]Patricia Anderson & Bruce D. Meyer, The Effects of Firm Specific Taxes and Government Mandates with an Application to the U.S. Unemployment Insurance Program, 65 Journal of Public Economics (1997) (also see this article’s citations for earlier research on the subject); Jonathan Gruber, 15 The Incidence of Payroll Taxation: Evidence from Chile S72-S101, Journal of Labor Economics (July 1997).
[6]William B. Conerly, Getting Back to Work: Reforming Unemployment Insurance to Increase Employment, Goldwater Institute Policy Report 6, (Jan. 26, 2004), citing Patricia Anderson & Bruce D. Meyer, Unemployment Insurance Taxes and the Cyclical and Seasonal Properties of Unemployment, 53 Journal of Public Economics 1-29, no.1 (1994).
[7]Alan J. Auerbach & Daniel Feenberg, The Significance of Federal Taxes as Automatic Stabilizers, 14 Journal of Economic Perspectives 37-56, American Economic Association (2000); George M. Von Furstenberg, Stabilization Characteristics of Unemployment Insurance, Industrial and Labor Relations Review 363-76, Cornell University (April 1976).
[8]James Sherk, Extended Unemployment Insurance – No Economic Stimulus, The Heritage Foundation, http://www.heritage.org/research/economy/cda08-13.cfm#_ftnref13 (Nov. 18, 2008).
[9]Kyung Won Lee & James R. Schmidt, 13 Unemployment Insurance and State Economic Activity, International Economic Journal 77-95 (Autumn 1999) available at http://www.iejournal.com/99fall/a7.pdf (“There appears to be no effective role served by state level UI benefits and contributions in providing stimulus or braking influences beyond the dollar for dollar correspondence of UI benefits and income that is guarenteed in the personal income accounts.”)
[10]Mark Gritz & Thomas MaCurdy, Measuring the Influence of Unemployment Insurance on Unemployment Experiences, Journal of Business and Economic Statistics (April 1997).
[11]John T. Addison & Pedro Portugal, How Does the Unemployment Insurance System Shape the Time Profile of Jobless Duration?, IZA Discussion Paper No. 978 (Jan. 2004); Lawrence Katz & Bruce D. Meyer, The Impact of the Potential Duration of Unemployment Benefits on the Duration of Unemployment, 41 Journal of Public Economics 45-72 (Feb. 1990); Bruce D. Meyer, 53 Unemployment Insurance and Unemployment Spells, Econometrica (July 1990).
[12]Ronald G. Ehrenberg & Ronald L. Oaxaca, Unemployment Insurance, Duration of Unemployment, and Subsequent Wage Gain, 66 The American Economic Review 754-66, No. 5 (Dec. 1976); Bruce D. Meyer, A Quasi-Experimental Approach to the Effects of Unemployment Insurance, NBER Working Paper 3159 (Nov. 1989);Bruce D. Meyer, 53 Unemployment Insurance and Unemployment Spells, Econometrica (July 1990).
[13]Bruce D. Meyer, A Quasi-Experimental Approach to the Effects of Unemployment Insurance, NBER Working Paper 3159 (Nov. 1989).
[14]Bruce D. Meyer, What Have We Learned From the Illinois Reemployment Bonus Experiment?, 14 Journal of Labor Economics 26 (Jan. 1996).
[15]Paul Kersey, Emergency Unemployment Benefits Not Needed as Economy Recovers, Heritage Foundation Executive Memorandum No. 914, February 13, 2004, at www.heritage.org/Research/Labor/em914.cfm.
[16]Brechling & Laurence, Permanent Job Loss, viii, 111; Donald R. Deere, Unemployment Insurance and Employment, 9 Journal of Labor Economics no 307-24 (1991).
[17]Patricia Anderson and Bruce D. Meyer, The Effect of Unemployment Insurance Taxes and Benefits on Layoffs Using Firm and Individual Data, NBER Working Paper 4960 (January 1996); Robert H. Topel, On Layoffs and Unemployment Insurance, 73 American Economic Review 541-59 (1983).
[18]David Card & Phillip V. Levine, Unemployment Insurance Taxes and the Cyclical and Seasonal Properties of Unemployment, 53 Journal of Public Economics 1-29 (1994).
[19]David Honigman & George C. Leef, It’s Time to privatize Unemployment Insurance, 45 The Freeman: Ideas on Liberty, ( Sept. 1995).
[21]William B. Conerly, Wasting Billions on Unemployment Insurance Overpayments, National Center for Policy Analysis, Brief Analysis No. 458, available at http://www.ncpa.org/pub/st/st274/st274b.html (Sep. 30, 2003)
[22]German Acevedo, et al., Unemployment Insurance in Chile: A New Model of Income Support for Unemployed Workers, Social Protection Discussion Paper no. 0612 (Oct. 2006).
