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Reforming unemployment insurance

Summary:
People rarely stop to think about just how bizarre our unemployment insurance system actually is. Imagine if automobile insurance worked as follows. After an accident, the insurance company paid you 0 dollars for each week that your car was out of commission, up to 26 weeks. That system would obviously encourage people to delay repairing the car. This is why insurance companies pay the insured a lump sum, right after the accident. I’ve long advocated the same system for unemployment insurance, in order to reduce work disincentives. Instead, the disincentive to work was actually increased by the UI reforms in the recent CARES Act. Some of the changes may have been beneficial, such as extending UI to independent contractors. But it’s hard to justify paying people

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People rarely stop to think about just how bizarre our unemployment insurance system actually is. Imagine if automobile insurance worked as follows. After an accident, the insurance company paid you $400 dollars for each week that your car was out of commission, up to 26 weeks.

That system would obviously encourage people to delay repairing the car. This is why insurance companies pay the insured a lump sum, right after the accident. I’ve long advocated the same system for unemployment insurance, in order to reduce work disincentives.

Instead, the disincentive to work was actually increased by the UI reforms in the recent CARES Act. Some of the changes may have been beneficial, such as extending UI to independent contractors. But it’s hard to justify paying people who don’t work more than they received on their previous job, even during times when jobs are hard to come by.

A new study by Attila Lindner and Balázs Reizer suggests that paying UI as a lump sum after the “accident” of job loss could be a win-win proposition.  Here’s the abstract:

We estimate the effect of front-loading unemployment benefit payments on nonemployment duration and reemployment wages. Exploiting a sharp change in the path of benefits for those who claimed unemployment benefits after November 1, 2005 in Hungary, we show that nonemployment duration fell by two weeks, while reemployment wages rose by 1.4 percent as a result of front-loading. We show that these behavioral responses were large enough to offset the mechanical cost increase of the unemployment insurance. We argue that our results indicate that benefit front-loading was a Pareto improving policy reform as both unemployed and employed workers were made better off.

Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment". In May 2012, Chicago Fed President Charles L. Evans became the first sitting member of the Federal Open Market Committee (FOMC) to endorse the idea.

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