Congress must stop unemployment tax increases from worsening crisis
When the stay at home orders end, our economy will not recover quickly. Depleted savings and fears about future coronavirus outbreaks will keep spending down and unemployment high. In order to speed up hiring, the next legislative stimulus package has to reform unemployment insurance taxes. Otherwise, hiring back workers will be unprecedentedly expensive precisely when we want it to be cheap to restart the economy.
Employers pay state and federal payroll taxes to fund the unemployment insurance benefits for laid off workers. The law forces “experience rating” these unemployment insurance taxes. This means that firms that have laid off workers over the past three years pay higher unemployment insurance taxes than those firms that have not. Experience rating discourages layoffs by making them more expensive and places the burden of unemployment insurance taxes on the firms most likely to conduct layoffs. In any normal economy, experience rating can help reduce unemployment.
In a recession, however, experience rating keeps unemployment high. At the beginning of a recession, firms lay off workers as demand plummets. Experience rating requires that unemployment insurance tax rates for the firms increase. But when these firms are ready to hire again they will also face particularly high payroll tax rates. During the last two recessions, the average unemployment insurance tax rates began to increase at the start of the downturn in the economy and peaked shortly thereafter.
A recession also depletes state unemployment insurance trust funds. The benefits are paid out of state trust funds that grow when unemployment is low. As unemployment filings inevitably increase during a recession, these state trust funds diminish. To replenish these pools of money, states raise unemployment tax rates for all employers during a recession, increasing the average unemployment insurance tax rates even further.
Experience rating and the need to replenish the unemployment insurance trust funds mean that unemployment tax rates peak right after a recession ends. Hiring new workers becomes most expensive at the same time there are the most unemployed workers. So not surprisingly, research indicates that high unemployment tax rates shortly after a recession prolongs labor market weakness, raising unemployment by about 10 percent.
The firms that have laid off workers over the last two months because of the coronavirus will face higher unemployment insurance tax rates when they reopen. This will reduce hiring and extend our worst downturn since the Great Depression. Unemployment insurance is supposed to mitigate downturns rather than exacerbate them. The next stimulus bill needs to prevent this train wreck. Congress should give enough funding to state unemployment insurance trust funds to keep them solvent.
Congress should attach two conditions to its support for the trust funds. First, states need to be forbidden from increasing overall unemployment insurance tax rates to facilitate hiring by all employers. Second, Congress should suspend experience rating of unemployment taxation for all layoffs over the last two months. Suspension of experience rating will prevent the recent wave of layoffs from triggering a major increase in unemployment insurance tax rates as firms consider hiring in the near future.
If Congress fails to address the problem of high unemployment insurance tax rates, then states could issue executive orders to temporarily suspend experience rating, as Connecticut has now done. Legislative action at the federal level to solve the problem systematically, however, is far superior to state responses. An even better option would be for Congress to end the procyclical pattern of unemployment taxes permanently.
If unemployment insurance trust funds are depleted by recessions, then we must impose higher tax rates in booms to guarantee we have enough in the downturns. Experience rating of unemployment taxes has to adjust for the fact that firms lay off workers at the start of downturns. Firms need to face higher unemployment insurance tax rates if they have more layoffs than average firms instead of being judged on a set standard.
This will keep average unemployment insurance tax rates stable over the business cycle even if actual unemployment rates are not. Unemployment insurance needs to lessen the pain of recessions both now amid this crisis and in the future. The 10 percent of Americans who make up the growing army of newly unemployed workers certainly deserve no less.
Yair Listokin is the Shibley Professor at Yale Law School and the author of the new book “Law and Macroeconomics: Legal Remedies to Recession.”