The Covid-19 pandemic has shut down businesses and locked people in their homes under shelter-in-place orders. A broad national shutdown has triggered an unprecedented increase in unemployment, with initial jobless claims increasing more than eleven-fold, to 3.3 million, last week and now another 6.6 million, just announced. To provide relief for the unemployed, the recently passed federal CARES Act supplements state unemployment-insurance benefits with an additional $600 per week through July 31. While relief and support for states is surely needed, the program is poorly designed. It provides incentives for employers to lay off workers. In the future—assuming the pandemic restrictions are lifted before August—it will discourage people from returning to work.

Unemployment insurance is administered at the state level, typically providing 26 weeks of benefits, representing a portion of previous weekly wages, up to a capped maximum. The “replacement rate”—the portion of pre-unemployment wages provided by the benefit program—varies across states. In 2019, the average replacement rate was 45 percent, but it ranged from 31 percent in Alaska to 56 percent in Hawaii. In recessions, the federal government has typically provided extended unemployment benefits, lengthening the duration of payments but not changing the levels. The current federal relief package extends unemployment benefits to 39 weeks, plus additional payments.

Under the new expansion, the average replacement rate across states would increase to roughly 116 percent. That is, an average worker could earn 16 percentage points more by collecting unemployment than he would on the job. Moreover, there is significant variation across states. The expanded benefits exceed 90 percent of the average weekly wages in all states; they exceed 120 percent of average in 21 states and 130 percent in six states.

In general, unemployment-benefit programs try to balance insurance with incentives, seeking to provide relief when needed while also offering motivation to look for work. States typically require recipients to search for a job. Setting the replacement rate well below 100 percent is usually a strong encouragement for them to do so.

Covid-19 presents unusual circumstances because unemployment has been enforced by government decree. Much of this joblessness will likely be temporary, with workers rejoining their employers once the pandemic subsides and restrictions are removed. Further, while some employers (Amazon, Walmart, grocery stores) are adding jobs, most companies are, at best, putting a freeze on hiring. The disincentive effect of unemployment benefits in the current crisis is minimal, while relief needs are large; thus, Washington has increased benefits, and many states are waiving job-search requirements.

Policymakers should be wary, though, of implementing relief provisions that will delay economic recovery, as occurred during the Great Depression and the 2008–2009 Great Recession. The Federal Pandemic Unemployment Compensation program is time-limited, but if the shutdown ends within the next four months, the aggressive unemployment-benefit replacement rates well in excess of 100 percent would hamper the labor market’s recovery.

Further, while the CARES Act includes other incentives for employers to retain workers, the Federal Pandemic Unemployment Compensation program implicitly encourages employers to lay workers off temporarily. With expanded benefits, at least 38 percent of workers in the U.S. would earn more in unemployment than they would working. Rather than struggling to make payroll during the shutdown, employers could save costs and give their workers a raise by laying them off.

A more direct solution would give grants to the states to fund new unemployment claims at a temporarily higher replacement rate. Now that the expanded program is in place, it is unlikely to be changed substantially, but tying the duration of expanded benefits to economic conditions would limit the negative effect. Congress could also introduce a program of re-employment bonuses that would better align incentives. These could provide modest one-time payments to unemployed workers who find a job, thus providing a direct job-search incentive. To avoid further incentive for temporary layoffs, these bonuses would not be payable to workers returning to their previous employer. Trial state-level reemployment-bonus programs in the 1980s showed significant success in getting the unemployed back to work, but the idea has not been implemented nationally. With unemployment rising more rapidly than ever before, the United States needs creative solutions to an unprecedented problem.

Photo by Karen Ducey/Getty Images


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