Front line of defense

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The limitations imposed by the role of the states in the U.S. unemployment insurance system are the reason why a majority of workers are not protected and why even insured workers receive inadequate protection. Steven Attewell writes: “Our reconstruction of the unemployment insurance system should start from three basic principles. First, unemployment is a national problem for our single, national economy, and requires a nation-wide system to respond to it. Second, in order to protect the entire workforce from the sudden shock of wage loss and the economy from the sudden shock of consumer spending collapse, all workers need to be inside the system, contributing and protected. Third, unemployment benefits should be set at a sufficient level to keep individuals and families from falling into poverty and should be automatically extended in periods of economic decline in job losses, when normal expectations that people can find new jobs no longer apply.”


One of the first casualties of the 2007 recession was in the realm of ideas. Prior to the recent economic collapse, Fed Chairman Ben Bernanke had confidently proclaimed an end to economic catastrophes. The advent of modern central banking and the liberalization of financial markets, he argued, had ensured that the kinds of systemic failures last seen in the Great Crash of 1929 would never happen again. Future recessions would be mild and short-lived, as central banks would spring into action to head off panicking markets, and the “automatic stabilizers” of the welfare states of the developed nations would kick in to prevent a panic from turning into a long-term slump in demand.

The last three years have taught us many lessons to the contrary. One of the things we have learned from the Great Recession is that America’s hybrid state/federal unemployment insurance (UI) system is essentially broken. The unusually sharp job losses – some eight million jobs lost from the outset of the recession in 2007 to the nadir of job losses in 2009 – caused a sharp decline in consumer spending of all kinds. For example, sales of motor vehicles and parts fell by an average of 11.1% during 2008 and 2009, while furnishings fell by an average of 4.4%. One of the purposes of our UI system is to prevent sudden downturns in employment in particular sectors, like construction or financial services, from turning into sudden declines of consumer demand that lead other sectors to start mass layoffs of their own.

And yet our UI system largely failed to counteract this slump. Most workers are not eligible, and many of those who are eligible do not get enough to keep themselves and their families out of poverty. States routinely exclude millions of workers from coverage and deliberately underfund UI systems that they are structurally incapable of operating in the midst of a recession.

If the U.S is to truly recover from our current Great Recession, and reform UI to prepare for future downturns, we need to take action now.

What is Wrong with UI?

When the architects of the Social Security Act designed our unemployment insurance system in the winter of 1934, they were hampered by structural constraints that do not exist today. They sought to cover a very different workforce, in which 10 million workers still worked in agriculture and 14 million or more workers flocked into ever-growing factories. In addition, the members of the Committee on Economic Security (CES) were vividly aware that they had to design a system that could pass review by a Supreme Court that had already struck down minimum wage and maximum hours laws as violations of “liberty of contract,” and was currently considering doing the same to the Agricultural Adjustment Act and the National Recovery Act. In the face of this expected hostility, CES staff members could not design a simple unemployment insurance (UI) system, financed by a single federal tax and managed solely by a national Social Security Board. Instead, they designed a complicated workaround in which a federal “regulatory” tax would be forgiven if states enacted their own unemployment insurance systems. This elaborate system was deemed acceptably federalist by the Supreme Court. The system that we know today – where 50 states operate their own UI systems, each setting a different payroll tax rate, eligibility standards, and benefit levels – was not a decision made on principle by all-knowing Founding Fathers. Rather it was a nakedly tactical choice made by Roosevelt administration officials who would have preferred to design their system along the same national lines as Old Age Insurance (Social Security). But whereas unemployment insurance had to design a complicated regulatory tax to get around existing state institutions (the Supreme Court’s federalist tendencies made a separate federal system that might override or conflict with existing state systems constitutionally suspect – hence the adoption of a “forgiven” regulatory tax), in the field of Old Age Insurance, no state systems existed. Thus OAI had a clear legal footing for a national program – politically, it was made clear a national program was Roosevelt’s line in the sand; Southern Democrats in Congress (once they were able to exclude agricultural and domestic workers) were willing to accede to the President’s demands.

From the beginning this design created a dangerous vulnerability within the UI system. Because 49 states have a constitutional requirement for balanced budgets and more than 26 states have constitutional limits on borrowing, states lack the federal government’s ability to resort to deficit spending in recessions. When recessions hit, states find themselves in an impossible bind. As consumption declines, sales tax revenue plummets; as businesses shed jobs and go out of business, corporate income tax revenue declines; as workers find themselves without steady paychecks, individual income tax receipts fall; and when millions of homes and business offices go into foreclosure and the real estate market collapses, so too does revenue from property taxes. While state governments stagger under the burden of sudden deficits, millions of previously-employed workers desperate for protection against total destitution increase the demands on unemployment insurance, thereby emptying state treasuries at a time when they are least able to respond.

What makes this worse is that the state-run nature of the UI system creates powerful incentives for states to underfund their UI Reserve Funds. Because states must fund their UI system with payroll taxes on local employers, reducing payroll taxes is often the first bargaining chip that states offer when trying to compete with one another to attract new firms from out of state. The lower the payroll tax rate, the cheaper it is to hire workers. Corporations respond to the leverage they have over furiously-bidding states to extract concessions so that they do not have to pay in at all, with the state covering their contributions. The result is a dangerous depletion of UI reserves. In the current recession, no less than 32 states have had to borrow billions of dollars from the U.S. Department of Labor because they let their UI funds run dry.

Many states have responded to their vulnerable position by restricting the number of workers who are eligible for UI. This reduces the drain on the system at the expense of workers who will have no protection when they lose their jobs. By keeping contributing requirements high, and by requiring longer “Base Periods” (the length of time one has previously worked in order to be eligible for UI), states are able to keep lower-paid workers and temporary workers from gaining eligibility for state funds. Similarly, by restricting eligibility to full-time direct employees, states exclude part-time workers and so-called “independent contractors” from coverage. To reduce labor costs, employers have responded to these changes by accelerating their project of replacing full-time workers by chopping full-time jobs into part-time jobs and by re-defining their workers as “independent contractors” even when they are working 100% of the time for one company. Looking to further reduce their costs in the current recession, employers have increasingly turned to professional UI claim-challenging firms.

In addition to restricting eligibility, one of the ways that states have attempted to limit their exposure to sudden increases in UI costs is to keep their benefits as low as possible, replicating the insidious patterns of pre-New Deal poor relief. At the moment, Mississippi and Alabama pay average benefits that are below the federal poverty line for a single individual, and every state except Hawaii pays an average benefit less than the poverty line for a family of four with two children. Such low levels of unemployment benefits are clearly unable to support previous levels of consumer spending, meaning that these states’ UI systems are failing as “automatic stabilizers” both for people who get benefits and people who do not. Liberal states like Massachusetts lack the fiscal capacity to do much more, paying an average benefit that falls just below the poverty line for a family of four.

Steven Attewell is completing his PhD in history at the University of California at Santa Barbara. He co-authors a blog called “The Realignment Project,” which discusses current policy and politics through the lens of history.

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