The unemployment insurance program was neglected during the
steady stream of good economic news in the 1990s.
States usually add to their unemployment insurance trust funds in
prosperous times, so they can draw them down in weak times. Perhaps
believing the good times would never end, however, many states have
failed to replenish their unemployment insurance funds or make other
fundamental changes that would strengthen the system.
Even in the "new economy," unemployment insurance still serves a
valuable purpose. The amount a family spends on food -- a bare
necessity -- falls 7 percent, on average, when the head of a
household becomes unemployed, according to a study published in The
American Economic Review by Jonathan Gruber of the Massachusetts
Institute of Technology.
Absent unemployment benefits, he estimates that a spell of
unemployment would cause food consumption to fall 22 percent --
about three times as much.
Indeed, with workers increasingly being promised stock options in
exchange for lower base pay, laid-off workers who are ineligible to
cash in on their options -- even if they are still worth something -
- are likely to depend on unemployment benefits even more to help
pay for housing and groceries.
Offsetting the salutary "consumption smoothing" effect of
unemployment benefits, many economists have also documented a
distortionary effect: As benefit generosity increases, workers tend
to remain unemployed longer.
Higher benefits apparently reduce the amount of effort people
devote to searching for a job.
In addition, research indicates that some employees and employers
game the system, placing workers on temporary layoff so they can
receive benefits while on vacation.
But these unintended consequences do not mean the program should
Doctors do not stop prescribing medicines just because they have
unintended side effects; instead, they weigh the expected benefits
of treatment against the cost of the side effects, and proceed
Ideally, the optimal unemployment benefit would balance the
desired consumption-smoothing effect against the undesired
According to Gruber's calculations, the average unemployment
benefit in the United States, which replaces around 40 percent of
previous earnings, after taxes, is close to the optimal level given
worker aversion to the risk of job loss.
The program is worth preserving. So it is important to ensure
that sufficient financing is accumulated in state trust funds to
weather a possible downturn.
A common measure of the solvency of unemployment insurance funds
is the "reserve ratio," or accumulated funds as a percent of annual
A higher reserve ratio provides more protection in the event of a
downturn. Phillip B. Levine, an economist at Wellesley College,
calculates that to remain solvent through a severe recession, like
the one experienced in the early 1980s, unemployment insurance funds
would require a reserve ratio of at least 1.25 percent.
Using this standard, 14 states are now at risk of insolvency in a
Texas and New York, with reserve ratios of 0.31 percent and 0.44
percent -- the lowest in the nation -- are skating on particularly
thin ice. …