Second, based on our theoretical model, the socially optimal rate of moving labor from contracting to expanding sectors can be achieved only when the transfer costs are borne either by the laid-off employee or by the employer in the contracting industry. The agent who pays for the transfer costs must also control the rate of transfer of labor.
Wages and prices adjust to different payment mechanisms to bring about the same socially optimal rate of labor transfer. Even if wages are not fully flexible, the socially optimal rare of transfer may still be achieved by charging the costs to the employer in the contracting sector. Furthermore, under the current system, laid-off workers are paid UI benefits on the condition that they actively search for alternative employment. Although this requirement is enforced with varying vigor in the states, it is designed to ensure that workers are, indeed, transferred to the expanding sectors at 3 socially optimal rate.
When the agent who pays for the adjustment costs does not control the rate of layoffs or hiring, there tends to be a large, non optimal adjustment of labor, or high structural unemployment. Since the government is usually not able to control the rate of transfer of labor, payment of the adjustment costs by the government (financed, for example, from general revenues) is non optimal. It may be argued that government financing is justified, to the extent that markets bring about too slow an adjustment. However, we conclude that, in general, experience rating (charging the costs of unemployment back to the contracting employers) generates socially beneficial results. This conclusion reinforces the finding that, with only temporary layoffs, increases in the degree of experience rating tend to lead to improvements in the allocation of resources.
Third, when layoffs are permanent, payroll taxes are not an ideal way of implementing experience rating. Temporary layoffs leave the taxable payroll (that is, the tax base) more or less unchanged, while permanent layoffs reduce the taxable payroll. Suppose, for example, that a firm’s layoffs increase and that the UI benefits received by the laid-off workers are charged to the firm’s account. If the layoffs are temporary, the taxable payroll remains more or less constant, and tax payments increase after a lag. If, by contrast, the layoffs are permanent, the taxable payroll and, hence, the firm’s tax payments fall immediately. After a lag, the firm’s tax rate and tax payments may rise to reimburse partially the UI system. In the limiting case, when the firm goes out of business, its taxable payroll and tax liabilities fall to zero. Thus, the charged benefits can never be recovered.
Our analysis shows that, under both systems of experience rating, UI tax liabilities are less than the benefit costs of permanent layoffs. In particular, when the firm is and remains at the maximum or minimum tax rate, it receives a tax reward for laying off workers permanently. This is the very opposite result to that intended by experience rating.
When the firm’s long-run position is on the experience-rated portion of the tax schedule and the maximum tax rate applies only temporarily, then the reserve ratio method of experience rating, because of its longer memory, tends to generate a higher ratio of taxes to benefit costs than is true with the benefit ratio method. In other words, the reserve ratio method tends to internalize a higher proportion of benefit costs than is true with the benefit ratio method.
We conclude this book with suggested economic policy changes. These recommendations are designed to increase the degree of internalization of the costs of unemployment. Some of our policy suggestions have been made before: increasing or abolishing the maximum and minimum tax rates and shortening the lag between benefit charges and tax increases would improve the performance of the systems.
Our relatively new policy suggestions refer to the reserve ratio method of experience rating. First, positive balances in the UI trust fund should be treated as part of the employer’s assets, and negative balances should be considered as liabilities. Second, upon bankruptcy, the firm’s positive or negative balance in the UI trust fund should be counted as part of business assets or liabilities. Moreover, the UI trust fund ought to be allowed to claim reimbursement for part or all of the firm’s UI liabilities in bankruptcy proceedings. Third, interest should be paid to the firm on its positive balances and charged on its negative balances. Together with the abolition of the maximum and minimum tax rates, these provisions could ensure the complete internalization of the costs of permanent as well as of temporary layoffs.
Much of the analysis underlying this study is abstract and mathematical. In our exposition we have attempted to present the arguments and principal findings first in intuitive terms and then more formally. We hope that this structure, which inevitably leads to some duplication, makes the research meaningful to a larger readership than would be the case with a tight mathematical presentation.
