The Hidden Cost of Unemployment Benefits
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The Hidden Cost of Unemployment Benefits

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One unintended consequence of the 2008 Emergency Unemployment Compensation (EUC) program may be that its ultra-generous length of benefit payments is actually contributing to the duration of joblessness and to the rise in unemployment.

A striking feature of the 2007-09 recession is the record length of time people have remained unemployed after losing their jobs. The Labor Deptartment's March employment report, which showed joblessness holding at 9.7 percent for the third month in a row, also noted that the average duration of unemployment continued to rise to 31.2 weeks, with 44.1 percent of the unemployed out of work for at least six months. The data go back to only 1948, but those numbers are clearly the highest since the 1930s, far exceeding the previous peaks reached during the severe 1981-82 recession.

Washington has responded to the urgent labor market conditions in a number of ways, but especially with actions to provide additional income support through unemployment insurance. Economists of all stripes recognize the importance of this program and other so-called “automatic stabilizers” that kick in during periods of economic weakness in order to lessen a recession’s impact. The benefits surely help, but they may also hinder. Many economists have examined the sometimes conflicting goals of unemployment programs that partially replace income while possibly creating disincentives to search for employment. A 2006 paper by Walter Nicholson and Karen Needels, published in The Journal of Economic Perspectives, notes that most studies conclude that each additional week of available benefits accounts for somewhere between 0.1 and 0.4 weeks of extra unemployment. A look at the current benefits landscape shows why the impact on the length of joblessness could be especially large right now.

From 26 to 99 Weeks
The unemployment insurance safety net is comprised of three types of programs. First, the basic plan is state operated, with most states offering 26 weeks of coverage. Second, an extended benefits program has been a permanent feature of the basic support system since the 1970s. It is half funded by states and half at the federal level, and offers an additional 13 weeks of benefits during recessions. Some states have voluntarily enacted plans that grant an additional seven weeks of extended benefits. This means that, prior to the recent recession, qualified out-of-work claimants could generally expect 39 weeks of benefits from the programs already on the books, with some states offering 46 weeks.

Adding Up the Benefits Weeks
Standard State Benefit26
Extended State Benefit (½ State, ½ Federal)13
Some State Largesse7
Initial 2008 EUC Legislation 13
EUC November 2008 7
EUC November 2009 14
EUC High Unemployment States (49) 13
EUC Severe Unemployment States (30) 6

Third, and apart from these two standing policies, are one-shot emergency unemployment compensation (EUC) programs that Washington has typically adopted during recessions. These temporary legislative efforts such as the 2008 EUC program are 100 percent federally funded. Because the states don’t have to pick up the tab for Washington’s emergency program, they offer their 13 or 20 weeks of extended benefits only after the federal benefits have run their course.

The 2008 EUC program greatly lengthened the availability of unemployment compensation far beyond any previous emergency policies. Because of wrangling over how to pay for the current program, Congress left for Easter recess without extending the EUC law, which is set to expire on April 5, along with the benefits of hundreds of thousands of unemployed people. However, lawmakers are expected to approve a retroactive extension of the expiration date when they return on April 12.

The 2008 EUC legislation, as initially signed into law in June 2008, offered an additional 13 weeks of federally funded compensation beyond the regular and extended state programs. The policy was expanded in November 2008 to add seven more weeks of coverage. In November 2009 Congress tacked on another 14 weeks to the duration of benefits for all states, and yet another 13 weeks for states with high unemployment, measured by a trigger that is currently low enough to cover 49 states. In states with even more severe unemployment, the law added still another six weeks, for which 30 states qualified as of Mar. 28. All totaled, the 2008 EUC program now adds a maximum of 53 weeks to the basic 39 or 46 weeks of coverage under the permanent state programs.

That adds up to a maximum duration of 99 weeks of benefits, depending on which states you look at.

Based on a conservative 0.2 extra weeks of joblessness and 47 weeks of additional unemployment compensation beyond the regular and extended state plans, J.P. Morgan economist Michael Feroli estimates that the generous extra benefits currently offered have increased the average length of unemployment by some 30 percent, or about five weeks, compared to the starting point of 16.5 weeks before the recession. Moreover, based on the 5 percent unemployment rate before the downturn, he estimates that the additional benefits account for about 1.5 percentage points of the rise in the jobless rate since the recession began.

Many economists have been puzzled by the extraordinary 5.1 percentage-point rise in the unemployment rate during the recent recession. That increase was well out of line with what would have been expected when looking at the traditional relationship between changes in real gross domestic product and changes in the jobless rate. This link, made famous by economist Arthur Okun in the 1960s, suggested that the 3.8 percent peak-to-trough drop in real GDP during the downturn would have resulted in a peak unemployment rate of about 8.5 percent, instead of the 10.1 percent high point hit last October. Ironically, Washington’s generosity may explain some of that gap.

Jim Cooper is an economist and former writer for Business Week who has been analyzing and forecasting the U.S. economy for more than 30 years