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Fixing Unemployment Insurance

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eye on the news

Fixing Unemployment Insurance

The pandemic has strained the system and exposed its inefficiencies. May 18, 2021
Economy, finance, and budgets

In recent weeks, with record levels of job openings, growing reports of businesses having difficulty hiring, and the April employment report coming in far below expectations, the role of unemployment insurance in the labor market has taken center stage in the public debate. While many argue that enhanced federal unemployment benefits discourage people from working, little attention has been given to the inefficiencies and poor administration of the unemployment insurance (UI) system that the pandemic has exposed.

Like all social insurance programs, UI has to strike a balance between insurance (providing replacement income during an unemployment spell) and incentives (encouraging people to find a new job). Over the course of the pandemic, that balance has eroded. The enhanced unemployment benefits in place since last spring—which, for many workers, pay more than earnings from employment—provide an incentive to remain unemployed. At the same time, problems in UI administration have led to lower payment rates and more delayed payments, with many workers falling through the cracks in the system. Finally, the changes in the unemployment system have created other incentives: expansions in eligibility, larger potential benefit payoffs, and diminished rates of fraud detection have all encouraged more workers—many of them ineligible—to apply for benefits.

With the onset of the pandemic last spring, unemployment increased at a rate never seen in the United States. UI became a lifeline for many workers, as the federal government stepped in with programs to expand the pool of eligible workers and to provide enhanced and extended benefits. The rapid increase in unemployment claims strained the UI system, which, in many states, is poorly administered with outdated technology. Non-payments and delays followed, limiting the program’s effectiveness.

Though initial unemployment claims are widely reported as a proxy for layoffs, only a fraction of those who file such claims will eventually get paid benefits. Further, those who do receive benefits often end up waiting a long time for payments. Over the course of the pandemic, this payment rate has fallen substantially, from 45 percent pre-pandemic to 20 percent in recent months. Meantime, between June 2020 and March 2021, 17 percent of all first payments nationwide were delayed more than 70 days, with an additional 17 percent held up between 28 and 70 days. Three states logged wait times of 70-plus days for more than 40 percent of their first payments. Too often, UI fails to live up to its goal of providing a timely income supplement for the unemployed.

This isn’t because claims are being unduly rejected. The expansions of UI eligibility, including the waiving of job-search requirements, as well as the general overload of the UI system, have resulted in fewer outright denials of benefits to workers deemed ineligible. In the first quarter of 2021, the denial rate was about 20 percent of initial claims, far below pre-pandemic levels (though much higher than mid-2020 levels).

Thus much of the decline in the payment rate stems from workers who would otherwise be eligible but had insufficient wages to qualify. While rules vary across states, this group includes workers with short work histories or earnings below minimum thresholds. In the first quarter of 2021, 48 percent of initial claims came from workers with insufficient wages. The draw of higher benefits—especially the introduction of the Pandemic Unemployment Assistance program, which provides benefits to workers not eligible for regular UI programs—accounts for this growth.

Another source of elevated claims is fraud. Of course, it is impossible to know just how many fraudulent claims have been filed and paid, particularly because the rate of fraud detection has dropped to near zero. The Department of Labor’s inspector general recently estimated that 10 percent of federal unemployment-insurance payments since March 2020 were improper largely because of fraud. Some states have reported surges in fraudulent claims and identity theft, but the rate of fraudulent cases detected by state unemployment systems has dropped dramatically—from about 2.7 percent of initial claims before the pandemic to less than 0.5 percent over the past year. With unemployment benefit payments rising sharply, and the likelihood of detection falling dramatically, one could plausibly expect a sizeable increase in cases of fraud.

All these changes mean that the pool of initial unemployment claims is substantially different from what it was before the pandemic, which we should bear in mind when interpreting recent news. Initial unemployment claims have fallen substantially to post-pandemic lows in recent weeks but remain more than double pre-pandemic levels. But adjusting for the large decline in payment rates brings reported initial claims down to pre-pandemic levels. In particular, assuming the payment rates continued, the latest weekly initial claims of 473,000 from the week ending May 8 would be comparable to a payment-adjusted pre-pandemic level of around 210,000—the actual level seen in early 2020. This suggests that instead of being a sign of increased layoffs, the continued high levels of initial unemployment claims are a sign of how much the unemployment system has changed.

In the near term, pressure on the system should abate. The federal UI expansions are set to expire in September, with a growing number of states (18, as of this writing) planning to terminate them even earlier. Returning to a lower benefit amount, with a smaller eligible pool of workers now facing job-search requirements, would encourage a return to work and stem the flow of claims applications. But though state UI systems would be under less strain, their inefficiencies would remain.

Longer-term changes are needed. Administrative reforms at the state level, including outsourcing the processing of claims from antiquated state systems to private businesses with advanced technology, could greatly improve the speed and efficiency of benefit delivery. A more fundamental change in the nature of unemployment insurance could have an even bigger impact both on incentives and efficiency. Over the course of the pandemic, I’ve argued for the introduction of reemployment bonuses, which would provide strong incentives for the unemployed to return to work. Montana was the first state to introduce such a plan.

But while a reemployment bonus can fix the disincentive effects of regular UI, it does not lighten the administrative burden. A more substantial change could come federally through the introduction of unemployment-insurance savings accounts, where workers pay into their own individual account and draw down the balance during an unemployment spell. Since workers manage their own accounts and want to economize on funds, they have stronger search incentives to shorten their unemployment spells. Such a system, in place in Chile, also reduces administrative burdens in verifying continuing eligibility and job-search behavior.

While the expansions of unemployment insurance are temporary, the strains and inefficiencies that the pandemic has exposed are persistent. Policymakers should take steps now to ensure that they don’t flare up again in the next downturn.

Photo: RyanKing999/iStock

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