Does unemployment insurance fuel economic growth?

Congress faces a year-end deadline on unemployment insurance. Currently, in states with the highest levels of unemployment, jobless benefits last for nearly two years. Extensions of benefits began in 2008 and have continued throughout the economic downturn. These extensions are set to expire, leaving all workers with the standard six months of benefits. President Obama has told Congress to make further extensions a priority:

“With millions of Americans still looking for work, it would be a terrible mistake for Congress to go home for the holidays without extending unemployment insurance. . . . Taking that money out of the economy now would do extraordinary harm to the economy.”

Here, the president is arguing that because the unemployed are likely to spend money that they receive rather than save it, the Keynesian multiplier will be high for unemployment benefits. Some evidence does support this hypothesis, suggesting that in the best case scenario, providing unemployment benefits can increase short-run economic output. However, this Keynesian view ignores the long run consequences of government provided unemployment insurance.

As jobless benefits continue to lengthen and unemployment insurance is funded with debt rather than payroll taxes, this program morphs from insurance to welfare. When policymakers make the case that unemployment insurance needs to be extended to protect the jobless and to spur the economy as a whole, they tend to ignore the perverse incentives that are inherent in the program. Unemployment insurance pays people not to work, and research has shown that longer unemployment benefits lead people to go without work for longer. Just before benefits end, the unemployed are most likely to find a job. By reducing the incentives for the unemployed to seek work, extended unemployment benefits prevent economic growth because they keep some people from working and adding to GDP.

While the federal government helps fund unemployment benefits, the unemployment trust funds are managed at the state level. Even before the economic downturn, many states lacked the reserves in these funds to handle an uptick in the number of unemployed workers. States are largely now funding unemployment insurance with loans from the federal government. A recent study from the Tax Foundation finds that states will be paying off these loans for years to come, facing higher interest rates as they continue to borrow increasing levels.

As Ben VanMetre wrote last week, rather than extending these flawed benefits, Congress should take up unemployment insurance reform. Eileen Norcross and I have argued that Unemployment Insurance Savings Accounts would provide the security of the current system without the unintended consequences. Under UISA, workers would contribute to individual savings accounts that they could access upon becoming unemployed. Because individuals would own their own accounts, they would not face incentives to remain unemployed in order to collect more benefits. Extending jobless benefits will not help either the economy as a whole or the unemployed in the long run, and turning unemployment insurance into a need-based program will only worsen its perverse incentives. Real reform would create improved incentives for all involved.