A Hamilton Project Discussion Paper

Fundamental Restructuring of Unemployment Insurance: Wage-Loss Insurance and Temporary Earnings Replacement Accounts

Abstract

This paper describes a revenue-neutral proposal to fundamentally restructure the system of social insurance after job loss in order to improve the protection against long-term effects of involuntary unemployment, provide a more progressive allocation of benefits, reduce incentives for firms to lay off workers, and encourage reemployment.

As part of this reform, the government would create a program of wage-loss insurance for reemployed workers that would augment the hourly wages of individuals who take jobs that pay a lower wage than was paid at their previous jobs. The reform proposal could reduce by half the share of laid-off workers who experience very large drops in wages at new jobs—from 14 percent to 7 percent.

In order to encourage return to work and to shift assistance toward those taking new jobs at lower wages (and away from those with new jobs at higher wages), traditional unemployment insurance payments would be replaced by withdrawals from temporary earnings replacement accounts (TERAs). As a complement to wage-loss insurance, TERAs would be structured to provide workers with the same ability to maintain living standards during unemployment as does the current UI system, while providing a mechanism through which workers could accumulate savings prior to unemployment and could borrow against future earnings if they subsequently exhaust those savings. One third of revenues that are contributed to the current UI system would be used for TERA withdrawals for those with very low wages and those who do not return to work after job loss. Revenues reimbursing these withdrawals would come from a more progressive payroll tax. Two-thirds of revenues that are contributed to the current UI system would be used for wage-loss insurance. Revenues for wage-loss insurance would be paid by firms based on the use of the system by their former employees. The proposal could be implemented by one or more states, or nationally.

The core principle of this reform is that smaller, short-term needs can be met through savings, borrowing, and repayment, so that the funds for insurance can be targeted to assist those facing larger, long-term losses. The proposed system would shift assistance toward workers experiencing significant long-term wage losses following reemployment, in comparison to the current UI system's focus, which is solely on short-term cash transfers to workers experiencing bouts of unemployment. The proposed system would provide equivalent access to funds needed to maintain living standards after job loss, and a significantly greater share of net program benefits to workers in the lower half of the income distribution when compared to the current system of UI benefits alone. This new system would also reduce unemployment by discouraging temporary layoffs and by creating stronger incentives for the worker to find another job quickly, and thus enhance economic growth.