It's Time to Privatize Unemployment; D. Honigman and G. Leef

This approach was very much in keeping with the collectivist philosophy of the era. Unfortunately, it has saddled us with a system that prevents workers from custom izing income-security plans for their needs. It is a system rife with inequitable cross subsidies between workers, and it is inimical to the nation's economic health. Of all the federal mandates that Congress could reDavid Honigman represents the 15th District in the Michigan Senate. George Lee/-an adjunct scholar of the Mackinac Institute-is the Sena tor's legislative aide. peal, this one should be near the top of the list. How the System Works The Social Security Act compels the states to establish unemployment insurance systems. They are given considerable lati tude in setting tax rates, benefit levels, eligibility criteria, and so on, but all must follow the same basic design. Employers pay a payroll tax, a certain percentage of each employee's taxable wage base. In Michigan, for example, employers can pay anywhere from 10 percent to .5 percent ofa taxable wage base of $9,500.Tax rates vary widely because they are based to a consid erable degree on each firm's "experience rating," which means the extent to which it has laid workers off and caused benefits to be paid. Even in highly experience-rated systems, however, benefits paid seldom match exactly with employer taxes.

Workers who become unemployed may qualify to receive benefits. To qualify, a worker must have earned at least a certain threshold amount, a means of limiting the system to those workers who have a fairly regular attachment to the labor force. An eligible claimant receives, usually after an administrative delay of several weeks, a check that usually replaces about half of his pre-tax earnings while employed, up to a given maximum. The unemployed worker 571 572 THE FREEMAN • SEPTEMBER 1995 must certify each week to the administering agency that he is able to and actively seek ing work. Ordinarily, the maximum period of time for which benefits are paid is 26 weeks. Many unemployed people do not, how ever, qualify for benefits. Those who quit their jobs, were fired for good cause, or did not have enough earnings, to give some common reasons, cannot collect. The Inequities of the System Whenever the government levies a tax on business, it creates a problem of tax inci dence. That is, who actually bears the bur den of the tax? Business taxes are borne by people in their capacities as workers, con sumers, and stockholders. Who actually pays the payroll taxes that fund the unem ployment insurance system? Mainly, the workers do. Unemployment insurance taxes represent part of the employee's total compensation package. What employers are willing to offer in wages and other benefits is reduced by the cost of benefits that the government has mandated. If the addi tion of a worker to the payroll will cost the company $500 in unemployment insur ance taxes, that worker will be paid approx imately $500 less in cash or other bene fits.

Just as the employer's "contribution" to FICA really comes at the expense of the employee, so is it with unemployment in surance taxes. Although commonly thought of as a free benefit to workers, the system is in reality a means of allocating their income in a way dictated by the state. Because the system is involuntary, however, workers are deprived of the chance to evaluate the benefits of participation in relation to its costs. For some workers, the unemployment insurance system is a bad deal. There are many who experience little or no unemploy ment during their careers, yet they pay-in the form of forgone wages or benefits throughout their working lives for some thing they may not want or need. For other workers, the system is a good deal. Workers who experience frequent periods of un employment may receive benefits signifi cantly in excess of their costs. As we men tioned above, experience rating is imper fect, and this means that workers who don't make much or any use of the system are forced to subsidize those who use it fre quently.

This is not necessarily a case of the wealthy subsidizing the poor. Some of those who frequently draw unemployment bene fits are high-wage, relatively wealthy work ers; some of those who are in stable em ployment and never collect are low-wage workers. The reverse is also true. The system capriciously redistributes income from stable-employment workers to unsta ble-employment workers. There is no justi fication for this coerced redistribution. The Economic Damage Done by the Unemployment Insurance System By providing American workers with a safety net in the event of unemployment, albeit one with several holes, the unemploy ment insurance system discourages that time-honored means of dealing with the possibility of loss of income-saving. Peo ple save less than they otherwise would since they believe that the unemployment system will be there to support them in time of need. If people made provisions for the possibility of unemployment by saving, there would bea greater supply of loanable funds, thus tending to lower interest rates and stimulate capital investments. Con versely, the funds accumulated in the sys tem are' 'invested" by the Treasury in U.S.

government debt obligations, which does little-to put it mildly-to help the economy grow. Not only does the present system discour age saving, it also leads to inefficient use of resources. It does so in several ways. First, it allows employers in businesses character ized by frequent periods of unemployment to externalize some of their labor costs. Seasonal firms, for example, would have to The Foundation for Economic Education Irvington-on-Hudson, New York 10533 Tel. (914) 591-7230 Fax (914) 591-8910 September 1995 A $5 Trillion National D.ebt B y the time you read these lines the debt of the federal government will have passed the $5 trillion mark. Does it surpass your imagination and abili tyjust to write the number? How many digits does it take? Are you aroused and alarmed about the ever-rising debt? Many Americans are fearful that it will lead to bankruptcy in one form or another.

They are right if we define bankruptcy in the broadest sense: the inability or unwillingness to pay legitimate debt, caus ing a loss of faith and reputation. Inthis sense, the federal government went bank rupt on the first day it resorted to inflation. After all, inflation is an insidious policy which allows government to make pay ment in depreciated dollars. The U.s. Government has willfully inflated the dol lar ever since the 1930s, has defaulted internationally on its gold-payment obliga tions, and continues to plunge into domes tic and foreign debt without any thought of repayment. If we view bankruptcy as the condition of being judicially declared bankrupt, the federal government cannot go bankrupt. There is no power on earth that can force the U.S. Government to disclose all its properties and distribute them equitably to its creditors. Even if there were such a supreme authority, the American people probably would rise in anger if the authori ty were to liquidate the vast land holdings and countless office buildings of the U.S.

Government and hand over the proceeds to foreign and domestic creditors. There is no thought of voluntarily sub mitting to bankruptcy proceedings, liqui dation, and distribution. Surely, no one expects the habitual spenders in govern ment to vote for a liquidation of govern ment property and its distribution to credi tors. "The government can always meet the debt obligation," they assure us. "It has the power to tax and the right to print money." Indeed, the power to tax may prevent gov ernmentdefault by placing the debt on the shoulders of taxpayers. But instead of one government defaulting, thousands of tax payersmay be forced to default. The num ber of American bankruptcies precipitated by tax exactions is legion. And the power to print legal-tender money creates the legal right to seize income and wealth from unsuspecting owners of money and mone tary claims by debasing the value of money. It confers the legal right to defraud creditors.

The spenders do not see it this way. "We owe it to ourselves" is their favorite motto. If they refer to American ownership of debt, they are mistaken. The federal debt is not held just by U.S. citizens and institutions. Foreign holders are the single largest group of U.S. creditors. The Bank of Japan is by far the largest owner, financing large blocs of U.S. budget and trade deficits and lending vital support to the U.S. dollar. Even if it were true that" Americans own it," such an attitude completely dis torts the situation. It ignores the difference between a creditor and a debtor, between a lender and a borrower. Facing an insolvent debtor, a banker will not take heart from the debtor's reassurance the "we owe it to ourselves." Similarly, the creditor of a U.S. Treasury obligation cannot take comfort from the assurance of the spenders that "we owe it to ourselves." Are we placing it on the shoulders of our children? The present generation is postponing paying for goods and services and is shifting the cost to the future. In this sense, the $5 trillion national debt becomes a huge pyramid of wealth consumed in the past and payable in the future. But the fed eral spenders reject such explanations.

They see a flow of future income from pre sent spending. There is no net burden shifted to the future, they contend, as long as future income exceeds the interest costs of the debt. In reality, there is little, if any, future income from present deficit spending. A present entitlement gives rise to loud demands for future entitlements, a current subsidy for future subsidies; it does not raise productivity and earn interest on the expenditures. Even where government invests its funds, the expenditures usually are diluted by waste, corruption, and mal investment. A public enterprise normally depends for its survival on tax exemption and taxpayer subsidies. The economic consequences of debt depend on the age of the debt. There is old debt to which the economy has completely adjusted and new debt to which the eco nomic structure must still adjust. The pri mary burden of new debt occurs in the pre sent in the form of a reduction in private consumption. The generation that wages a war bears the primary burden.

Government expenditures withdraw resources from private production and con sumption. World War I withdrew some 25 percent, World War II almost 50 percent. The same is true in the' case of peacetime deficit spending. It withdraws economic resources from private production and redirects them toward government con sumption. Surely, the redirection differs materially from wartime direction, but the process is the same. Deficit financing generally involves the consumption of someone's savings. Government enters the credit market and offers IOUs in the form of Treasury bills, notes, and bonds. Massive deficits con sume productive capital on a massive scale. As capital lends productivity to labor, the capital consumption instantly reduces labor productivity and output. If the deficit is not promptly corrected by a bud get surplUS and the capital consumption replaced by capital formation, productivity and output will be reduced forever. It is impossible to fathom the costs of the $5 tril lion federal debt in permanent income and wealth.

Government deficits not only consume productive capital but also cause much remaining capital to readjust toward gov ernment consumption. As wartime deficits not only consume productive capital but also cause private capital to move into ammunition and armament industries, so does peacetime deficit spending consume productive capital and cause capital to move into the favored industries. Unhampered private production arid con sumption thus suffer a double punishment and contraction. Future generations which inherit the debt are wronged in several ways. They come into an economy that is enfeebled and emaciated by capital consumption. The apparatus of production is maladjust ed, addicted to political spending, and sus ceptible to political intrigue and arbitrari ness. The whole financial structure is made to rest on the pyramid of federal debt, which makes all finance rather precarious.

Worse yet, they must tax themselves to cover the interest on the debt which they did not incur. Failure to bear this burden would have consequences too ominous to contemplate. To expect them to repay our debt is to indulge in airy hopes and golden dreams. Debts, follies, and crimes are generally mixed together; the federal debt is a $5 trillion mixture. '/ d__/../ "k~~l Hans F. Sennholz LABOR DAY SALE Eugen von Bohm-Bawerk THE EXPLOITATION THEORY This extract from Capital and Interest explodes all Marxian arguments against interest income Regular $9.95 Sale $ 7.95 Clarence B. Carson THROTTLING THE RAILROADS 9.95 7.95 Every sort of intervention has destroyed a vibrant industry. THE WAR ON THE POOR 14.95 10.95 A description of how the welfarist programs have been, in practice, a war on the poor. Freeman Classics AMERICAN UNIONISM: FALLACIESAND FOLLIES 14.95 11.95 The intellectual origins and economic implications of the union ideology.

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Fall Round-Table Discussions O ur series of very successful Round-Table events returns this f.all with a lineup of eminent speakers. Our evenings begin with a reception at 5:00 P.M., followed by dinner at 6:00. We are then entertained by a presentation given by our featured speaker. After that, the floor is opened for an exciting exchange of ideas. Charge is $40 per person per event; certain discounts are available. Attendance is limited; call or write Dr. Barbara Dodsworth at FEE for reservations (phone 914-591-7230; address, 30 South Broadway, Irvington, NY 10533). October 7 Round Table Murray Sabrin, host of his own radio show on WVNJ on money matters, will present his view of taxation: "'Progressive Tax? Flat Tax? How About No Tax?" November 4 Round Table Morris Markovitz, who is the president of the very successful Mercury Management Associates, Inc., will reflect on "'The Myth of the Trade Deficit."

December 2 Round Table Doug Bandow of the Cato Institute in Washington, D.C., will entertain us with his discussion of foreign aid in "'Foreign Aid: New Bottles, Old Wines. o o The Foundation for Economic Education Reunion Celebrating its Golden Jubilee with Lady Margaret Thatcher The Waldorf-Astoria Hotel New York City April 11 , 1996 ~ Mark your calendar! An opportunity that comes only once in a lifetime.

IT'S TIME TO PRIVATIZE UNEMPLOYMENT INSURANCE 573 pay their workers more if it weren't for the fact that the unemployment insurance sys tem subsidizes their operations. Because of this subsidy, we get more seasonal employ ment than is optimal. Second, since the system relies on a third-party payor for its benefits, it leads to greater costs than if that third party could be'avoided. That is especially true where the third party is a government bureaucracy. We have an extensive unemployment insur ance administrative and dispute-resolving bureaucracy. If we moved to a system that avoided much of the third-party involve ment, we would save resources for more productive things. The Voluntary Alternative What if we allowed workers and employ ers to handle provisions for unemployment as they think best? How would they react? Workers differ greatly as to their expec tations on the probability of unemployment and the harm it would do them. There is an enormous range from those who are sure that they are set for life in their current employment to those who are rarely sure where the next paycheck will come from.

Those in the former category might ratio nally decide that they don't want to give up anything in order to have a measure of income security in the event of unemploy ment. Those in the latter category would, in contrast, regard income security as a high priority. Whatever their degree of concern over the possibility of unemployment, there are two ways for workers to shield themselves against it. One is saving; the other is risk pooling (insurance). Saving is the time-honored means of pro viding security against the possibility of unemployment or other adverse occur rence. What if we allowed people to set up Individual Unemployment Accounts (IUAs) analogous to IRAs? The individual would decide how much, if anything, to deposit (or have withheld from his pay check) into the account each pay period. Taxes would be deferred until such time as funds were withdrawn. During periods of unemployment, the worker would decide how much to withdraw from the account. If there were funds in the account at the time the worker retired, he could treat it as an IRA. Given the popularity of IRAs, espe cially when they were fully tax-deductible, it seems likely that IUAs would catch on very quickly.

We are not fond of the tendency to en courage people to set up savings accounts for particular purposes (retirement ac counts, medical savings accounts, our pro posed unemployment accounts, etc.). It would be better to repeal the tax code's bias against saving and just let people save with out having to pigeonhole the money. But short of that, IUAs would have several major advantages over the status quo. First, there would be no involuntary re distribution of income among workers. With each individual saving for himself, the risk of unemployment would no longer be so cialized. True, some might be improvident, but that is hardly an adequate reason to force some to subsidize others. Second, people would have the maximum incentive to find new work after becoming unemployed, since withdrawals from IUAs would be withdrawals of personal wealth. Not all unemployed workers are as diligent as possible when it comes to finding new work now, since the checks come from the government and stops once employment has been re-established. That is, unemployment insurance subsidizes unemployment, and therefore increases its incidence.

Third, the existing bureaucracy would be unnecessary. With IUAs, the decision making would be individual rather than bureaucratic. Fourth, as we have already said, an in crease in saving would be economically beneficial for the United States. Risk-pooling is the other means by which people can protect themselves against ca lamities. People enter into insurance con tracts when they choose to pool the risk of losses due to auto accidents, fire, ill-health, and so forth. Could there be a private insurance market for unemployment insur574 THE FREEMAN • SEPTEMBER 1995 ance? In the early years of this century, there were several attempts by major insur ance companies to write unemployment in surance, but each time they were thwarted by state insurance regulators who claimed that unemployment was inherently uninsur able. Of course, once the government man dated that everyone have its unemployment coverage, all thoughts of private insurance disappeared.

We see no reason why voluntary risk pooling for certain types of unemployment could not work. (It is not possible to insure against being fired for cause, since that is within the individual's will.) People already can insure that their mortgage payments will be made if they should·lose their jobs. If the government got out of the unemployment insurance business, private alternatives would swiftly emerge, almost certainly giv ing workers more flexibility than the current system does. Workers who had not built up sufficient funds in an IUA to feel that they had enough of a cushion would probably want to buy unemployment insurance, either individu ally or as an employer-provided benefit. How much insurance to have should be left up to the individual. How much to save should be left up to the individual. We have no idea what combination of insurance and/or saving would be best for people and neither does the government. That's why it should be left to personal decision.

If we could privatize unemployment in surance, what would we do with the money currently in the trust funds? Given our anal sis that these taxes are borne by workers, the proper answer is that the money should be returned to them. Michigan's trust fund is now approximately $1 billion. Although it would certainly not be easy to divide this amount up among current and retired work ers based on how much they' 'paid" into the system, it would not be impossible. Conclusion The collectivist approach to unemploy ment insurance is an anachronism. Aban doning the old system and replacing it with freedom of choice and individual contract would not only be more efficient economi cally, but would also be consistent with the fundamental American belief that people should be masters of their own lives, not pawns to be moved about at the will of others. Our conviction is that we would develop a system for unemployment compensation that is both fairer and more beneficial to the economy if we stopped relying on coercion and went back to relying on voluntary cooperation. 0 Back-to-School Special Recent Issues of THEFREEMAN for Classroom Use H ere's your chance to introduce students to The Freeman at little cost to you or your school. We are offering cartons of back issues of The Freeman for the modest charge of $10.00 per carton (within the United States) to help defray our shipping and handling charges. Each carton contains over 100 copies. Payment must accompany order.