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Unemployment Compensation: None of the Government’s Business

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The New Deal ushered in a lot of socialistic ideas that still plague us, and one of the worst is the notion that the government should protect people against the loss of income. If a person suddenly finds himself without employment and, therefore, without a paycheck, “society” supposedly has an obligation to help support him until he finds employment once again. Inspired by that collectivist thought, Congress wrote a provision into the Social Security Act that requires the states to establish coercive tax-and-redistribute unemployment insurance (UI) systems. Without much concern for the long-run consequences, Congress turned what had always been an individual responsibility — making preparations for the unpleasant possibility of unemployment — into a governmental one.

This was an enormous mistake. Governmental UI systems are incompatible with individual freedom, inequitable, and economically damaging to the country. We can and should restore to the individual the right and responsibility to make his own arrangements to deal with the possibility of unemployment.

How does UI operate? Although the states have some latitude in setting the details of their systems, all must follow the same general outline. Payroll taxes are levied on employers to acquire the funds to run the system. Usually, the taxes paid depends on the employer’s “experience rating,” that is, the extent to which the firm has laid off workers who then collected benefits. Employers that have more UI claims against them pay more in taxes. But even in the those states that have the most extensive experience with UI, the correlation is not exact. Firms with high layoffs never pay as much as is paid out to their employees. And firms with a stable workforce pay in more than what is paid out to their unemployed workers.

On the benefits side, state law establishes the criteria for eligibility to collect as well as the amount of the payment. In Michigan, for example, to be eligible to collect, you have to be unemployed but actively seeking work (the government takes your word on that), be unemployed through no fault of your own (but seasonal workers, who know that their jobs will end as of a certain date, can still qualify), and have earned at least $100 in twenty of the preceding fifty-two weeks. Those eligible to collect receive weekly checks for about two-thirds of their previous after-tax earnings, but not to exceed $300 per week. The eligibility period is twenty-six weeks.

That condenses more than one hundred pages of law into two paragraphs. The details are mind-boggling, and it takes an extensive (and, of course, expensive) bureaucracy to oversee it all.

How does UI really work? The fact that the UI system is funded through payroll taxes obscures the true impact of this coercive system. Businesses do not truly pay any taxes. Only people pay taxes. To levy a tax on a business is to levy it on some combination of the following groups of people: consumers, employees, and equity holders. Economists have long debated precisely how the burden of business taxes is actually felt, and there probably is no single right answer. It depends on how the business adjusts after the imposition of the tax.

In this case, we believe that most of the burden of the tax falls on the employee. Employers, knowing approximately how much they will have to pay in UI taxes for each employee, factor that amount into the total compensation package they offer the employee. Just as employers do not really pay “their” half of the Social Security tax — but instead reduce the cash compensation paid to workers — the real cost of UI taxes ultimately falls on the employees. It is best thought of as a mandated benefit that subtracts from other benefits the worker could have had. Whether they think it is worth it or not, workers have to pay for their “safety net.”

Individual employees are, of course, different in many respects, and one of these differences is the degree with which they will experience periods of unemployment. Some people enter occupations where the work is very steady; others enter into occupations where the likelihood of protracted periods of unemployment is high or even certain. Those who find themselves steadily employed will probably never collect a penny in UI benefits, but are (indirectly) forced to subsidize those who have entered into lines of work where employment is sporadic. This involuntary transfer is one that should trouble even leftists who see nothing wrong in robbing Peter to pay Paul, since many of the jobs characterized by steady employment-retail sales, for example — pay considerably less than do many high-unemployment jobs, such as construction. The less wealthy are forced to subsidize the unemployment of the more wealthy. Where is there any justice in that?

Consider also that many unemployed people do not meet the eligibility criteria and thus cannot collect any benefits. Someone who voluntarily quits to find a better job is not entitled to collect. Someone who works only part time may not have earned enough to collect. Someone who is fired for cause cannot collect. These people have all helped to fund the UI system and when the paychecks stop are just as much in need of money as are people who qualify. But they are not eligible. Such unfairness is an inevitable feature of government programs that purport to solve “social problems.”

Besides forcing some workers to subsidize others, there are other adverse consequences of the UI system. It certainly depresses the rate of saving that would otherwise exist. Once they are told that the government will take care of them during periods of unemployment, many people will save less or nothing at all. Providing funds for the possibility of future financial hardship is one of the strongest motives for people to save. Take that away and, naturally, you get less saving. Less saving, in turn, means less capital formation and investment. Our economic growth rate is slower than it would otherwise have been, thanks to our UI system.

Another consequence is that we make ourselves poorer by wasting resources. The present UI system wastes resources in two ways. First, we have more unemployment than we would in the absence of UI. The system reduces the incentives that people would otherwise have to diligently seek new work after losing a job. If they are looking at all, UI recipients are apt to be much more fussy about the work they will take if they know that a government check will keep on coming if they turn down a job offer. The unemployed do not have to bear the full costs of their actions, so we have higher levels of unemployment. That means lower economic output.

Second, we waste resources by employing large numbers of people for nonproductive purposes in the administration of the UI system. Legions of bureaucrats are needed to run this complicated system. Tremendous numbers of work-hours are soaked up in needless paper shuffling and dispute resolution. If we dissolved the present UI system, all of those people could find productive work.

What is the solution to this mess? What if we decided to let freedom work and repealed the laws that have saddled us with this coercive, inequitable, and wasteful system? Workers would then have to individually assess both the probability that they would become unemployed and the harm that unemployment would do to them and then take whatever steps — either individually or in cooperation with others — deemed optimal to provide a personal safety net.

What steps could workers take? First, they could save. That is the ancient, time-honored means of providing a cushion against financial hardship. By saving for the possibility of unemployment, a person takes responsibility for his future in his own hands. He acknowledges that he has no moral claim on the earnings of others when he is out of work. That is the way it must be in a free society.

How much a person saves is up to him. He may perceive his probability of unemployment as negligible and therefore save little for that reason, although he may save a lot for other reasons. (The modern trend toward forcing people to compartmentalize savings is a bad one, an outgrowth of the pervasiveness of the income tax. The benefits of saving are heavily taxed unless you are saving for an approved purpose and go about it in an approved way. If people want to set up separate accounts for retirement, medical expenses, college costs, and so forth, they certainly may do so, but there is no reason why they should have to go to the extra bother. Money is fungible. One saving account would probably do nicely for most people.) On the other hand, he may perceive that he faces a strong probability of unemployment and, therefore, decide to set aside a fairly substantial portion of his income. His employer may facilitate his saving preferences with some kind of program, but if not, it is quite easy for an individual to establish a savings plan with any number of financial institutions. If he becomes unemployed, he would draw upon the funds in his savings account at whatever rate he thought best.

Notice that reliance upon individual initiative desocializes the risk of unemployment. No longer would one person’s misfortune or laziness be a burden to everyone else. Also, notice that it works without the need for any government bureaucrats, further reducing the burden upon the taxpayers.

There is a second non-coercive way of protecting against hazards that people might wish to avail themselves of — namely, insurance. Insurance is the voluntary pooling of risk. We have never had a market for unemployment insurance in the U.S. because state insurance regulators blocked it in the early years of this century because of the government’s entry into the field during the New Deal. (Metropolitan Life repeatedly sought permission to sell unemployment insurance but was rebuffed by state insurance commissioners.) But there is no reason why there cannot be private unemployment insurance. You can already purchase insurance to cover your mortgage payments if you should lose your job.

Unemployment insurance might be provided as a fringe benefit or might be purchased individually. Those who do not think they need this kind of insurance would forego it; those who do would seek the optimal amount and best terms, given their circumstances. By getting the government out of the picture, we would enable individuals to customize their preparations for the possibility of unemployment to their own perceived needs. No one would be forced to subsidize anyone else.

But what if some people failed to save enough or to obtain unemployment insurance? Then, they would have to look for a new job very diligently. Private charities would probably assist such people in the interim, but employees could not take that for granted. People who failed to take adequate precautions would learn from unpleasant experiences and adjust their behavior accordingly. The existence of the government’s “safety net” promotes imprudent behavior. Individual responsibility would do just the opposite.

But no matter what imprudent people do, their behavior is no reason to infringe upon the freedom of everyone else. Just because some people might fail to take adequate precautions against the possibility of unemployment is no justification for forcing everyone to participate in a coercive, inequitable and wasteful system.

We have put up with the government’s collectivistic UI system for more than sixty years. That is long enough for it to have become something of a sacred cow. Most people unthinkingly accept it and have never considered any alternative. The notion that unemployment compensation must be a function of the government is deeply ingrained. But it is mistaken. Individuals can and should make their own preparations for periods of unemployment and they can do so better than government. The entire UI system should be repealed. Any step short of that is inconsistent with the ideal of human liberty.

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    Senator Honigman represents the 15th District in the Michigan Senate. Mr. Leef is an adjunct scholar with the Mackinac Center for Public Policy in Midland, Michigan, and serves as Senator Honigman's legislative aide.