TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Friday, September 1, 2017

Weekly SSRN Tax Article Review And Roundup

This week, Orly Mazur (SMU) reviews a new work by Brian Galle (Georgetown), How to Save Unemployment Insurance, forthcoming in the Arizona State Law Journal.

Mazur (2017-2)With the Labor Day Holiday upon us, what a perfect time to celebrate American workers by considering how best to provide workers with a source of relief in the event of involuntary unemployment. Brian Galle’s compelling new work does exactly that by analyzing and suggesting potential reforms that can help to save our unemployment insurance (UI) program.

The UI program is a form of social insurance that provides temporary income support to workers that lose their jobs through taxes collected by state and federal governments from employers. Unfortunately, as the recent Great Recession showed us, “the U.S. system of financing its unemployment insurance program is seriously dysfunctional.” After explaining the cause of the UI program’s failings, Galle makes a persuasive case that for any UI reform proposal to be effective, three factors need to be taken into account. 

First, government officials tend to exhibit short-sighted behavior with respect to fiscal decisions, which results in states collecting an inadequate amount of unemployment taxes. As a result, incentives that result in immediate benefits or penalties to states are more effective than incentives or penalties that have a future effect. Second, the moral hazard resulting from certain features of the UI program need to minimized in order to successfully improve the UI financing system and ensure the solvency of the program. In particular, to ensure sufficient funding to pay out benefits during times of recession, states need to accumulate adequate balances in their UI trust fund accounts during good times. Currently, certain policies inadvertently encourage states to impose low unemployment taxes and take the risk that they will have insufficient UI funds to pay promised benefits in the event of a recession. Finally, the mobility of employers is another factor to consider when designing UI reform proposals. Because UI is primarily financed and administered at the state level, if states impose higher unemployment taxes on employers in order to offer high unemployment benefits, they face the risk that businesses will move to a state with lower taxes. As Galle notes, “this creates unrelenting political pressure to hold taxes low,” as well as a “race to the bottom.”

Taking these factors into account, Galle then analyzes the shortcoming of existing UI reform proposals to suggest a series of additional options that are likely to achieve better results. These reform proposals include not only ways to increase UI financing, but also ways to increase the likelihood that employees receive benefits when they need them most. For instance, he suggests (i) imposing an additional federal tax penalty on employers in states with severely inadequate UI trust fund balances, (ii) granting tax discounts to employers in states that have demonstrated sufficient UI financing on the basis of specified metrics, (iii) the use of alternative metrics to trust fund balances to measure the state’s success in adequately saving for future contingencies (iv) increasing federal involvement in developing rules and administering the states’ UI systems, (v) automatically enrolling qualified employees for UI benefits, and (vi) repealing federal income taxes on UI benefits. Although each of these options has its own limitations, which are discussed in the paper, Galle uses recent theoretical and empirical work in behavioral economics to demonstrate how each option is an improvement over our current system and the majority of the existing reform proposals.

In short, Galle argues convincingly that a change to our UI program is needed and that the change needs to occur now, while our economy is recovering. The solvency of the UI program is critical to its success and to its ability to provide families with adequate benefits and to combat economic downturns. Moreover, even without a looming recession, the stability of the UI program is likely to be tested in the near future as the rise in robotics and the automation of work displaces workers and creates fewer jobs. With less workers in the workforce, this situation will increase the number of workers needing UI benefits, while at the same time will decrease the amount of UI taxes that employers pay. Given this change and other global economic trends that may affect the rate of unemployment in the United States, the current administration would be wise to take note of Galle’s work and adopt policy reforms now that can save our unemployment insurance program.  Happy Labor Day!

Here’s the rest of this week’s SSRN Tax Roundup:

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