Gruber4e ch14

Public Finance and Public Policy Jonathan
CopyrightGruber
© 2010Fourth
WorthEdition
Publishers
Copyright © 2012 Worth Publishers 1 of 32
Unemployment Insurance, Disability
Insurance, and Workers’ Compensation 14
14.1 Institutional Features of Unemployment Insurance,
Disability Insurance, and Workers’ Compensation
14.2 Consumption-Smoothing Benefits of Social
Insurance Programs
14.3 Moral Hazard Effects of Social Insurance Programs
14.4 The Costs and Benefits of Social Insurance to Firms
14.5 Implications for Program Reform
14.6 Conclusion PREPARED BY
Dan Sacks
Public Finance and Public Policy Jonathan Gruber Fourth Edition Copyright © 2012 Worth Publishers 2 of 32
CHAPTER 14 ■ UNEMPLOYMENT INSURANCE, DISABILITY INSURANCE, AND WORKERS ‘ COMPENSATION
14
Unemployment Insurance, Workers’ Compensation,
and Disability insurance.
• Unemployment insurance, workers’ compensation,

and disability insurance are three of the largest social
insurance programs in the United States.
• They share many common features.
o They operate in similar ways.
o They provide similar insurance.
o They generate similar moral hazard concerns.
14.1
Institutional Features of Unemployment Insurance
• Unemployment insurance: A federally mandated,

state-run program in which payroll taxes are used to
pay benefits to workers laid off by companies.
• Partially experience-rated: The tax that finances the UI
program rises as firms have more layoffs, but not on a
one-for-one basis.
• Averages 1.71% across states.
• Qualifications: minimum earnings amount, cannot quit
or be fired for cause, must be looking for work.
14.1
Unemployment Insurance Benefits Schedule
• Benefits depend on weekly earnings.

• Benefits rise with earnings up to a maximum amount.
• The replacement rate is less than 100%.
o National average: 46%
o Low: 33% in Alaska
o High: 56% in Rhode Island.
• Maximum amount and maximum duration covered,
also vary across states.
14.1
Unemployment Benefit Schedule for Michigan
14.1
Institutional Features of Disability Insurance and
Workers’ Compensation
• Disability insurance: A federal program in which a

portion of the Social Security payroll tax is used to pay
benefits to workers who have suffered a medical
impairment that leaves them unable to work.
• Workers’ compensation: State-mandated insurance,
which firms generally buy from private insurers, that
pays for medical costs and lost wages associated with
an on-the-job injury.
14.1
Maximum Indemnity Benefits Paid to Select Types of
Work Injuries in 2012
Temporary Injury
State Hand Eye Foot (10 weeks)
Hawaii $171,065 112,174 143,723 6,960
Michigan 162,719 122,607 122,607 7,390
New York 104,627 68,608 87,904 5,000
Indiana 67,000 54,136 54,136 6,200
Mississippi 56,463 37,642 47,053 7,399
14.1
Institutional Features of Workers’ Compensation
Workers’ Compensation provides no-fault insurance.

• No-fault insurance: When there is a qualifying injury,
the workers’ compensation benefits are paid out by
the insurer regardless of whether the injury was the
worker’s or the firm’s fault.
• Reduces transactions costs since no lawsuits are
needed.
14.1
Comparison of the Features of UI, DI, and WC
Characteristic UI DI WC
Qualifying Event Job loss, Disability On-the-job
job search injury
Duration 26-65 weeks Indefinite Indefinite
(if verified)
Difficulty of Job loss: easy Somewhat Very difficult
verification Search: impossible difficult
Average after tax 47% 60% 89%
replacement rate
Variation across Benefits and other Only disability Benefits and
states rules determination other rules
14.1
APPLICATION: The Duration of Social Insurance
Benefits around the World
• These programs have distinct time patterns, paying

out for 26 weeks or indefinitely.
• Unemployment insurance lasts much longer in many
European countries than in the United States.
• Appropriate time pattern balances three factors:
o Moral hazard: increases with length,
o Consumption smoothing: increases with length,
o Benefit targeting: increases with length.
14.1
APPLICATION: The Duration of Social Insurance
Benefits around the World
14.2
Consumption-Smoothing Benefits of Social
Insurance Programs
• There is relatively little evidence on the consumption-

smoothing implications of these programs.
• Most direct study: Gruber (1997)
o Individuals are not fully insured by other sources
against the income loss of unemployment.
o Consumption falls significantly when they lose
their jobs.
o Higher levels of UI lessen the negative effects of
job loss.
14.3
Moral Hazard Effects of Unemployment Insurance
14.3
EVIDENCE: Moral Hazard Effects of Unemployment
Insurance
• Meyer (1989) studied how New Jersey’s increase in

benefits affected unemployment durations.
o Maximum weekly benefit increased from $350to
$400.
o Only high income workers saw a benefit increase
(group H). Workers with weekly earnings below
$700 were unaffected (group L).
o Overall, 10% increase in benefits increases
durations by about 8%.
14.3
EVIDENCE: Moral Hazard Effects of Unemployment
Insurance
14.3
Normative Implications of Longer Durations
Do longer durations represent an undesirable outcome?

• Yes, if UI is subsidizing unproductive leisure.
• No, if UI is helping people find higher quality job
matches.
o Job match quality: The marginal product
associated with the match of a particular worker
with a particular job.
• Wages do not increase with UI generosity, suggesting
UI does not improve match quality.
14.3
Evidence for Moral Hazard in DI
14.3
EVIDENCE: Moral Hazard Effects of DI
Gruber (2000) studied Canada’s DI system:

• In 1987, the rest of Canada increased its benefits to
equal those in Quebec, raising the replacement rate
for the typical disabled worker from 25% to 33%.
• Labor force participation rates of older men in the rest
of Canada declined as benefits increased.
• The response was modest relative to the enormous
36% increase in benefits.
• Implied elasticity of labor supply with respect to
benefits only about 0.3.
14.3
Evidence for Moral Hazard in WC
Krueger (1990, 1991) studied a benefit increase in MN:

• Every 10% increase in benefits generosity led to a 7%
rise in the rate of reported injury.
• Each 10% rise in benefits led to 17% longer durations.
• The response of injury durations to benefits increases
is much stronger for hard-to-verify injuries than for
easier-to-verify injuries.
• On Mondays there is a large rise in sprains and strains
relative to lacerations.
14.3
EVIDENCE: Krueger’s Study of Workers’
Compensation
14.4
Partial Experience Rating in Vermont
14.4
The Effects of Partial Experience Rating in UI on
Layoffs
• Partial Experience Rating Subsidizes Layoffs

o Workers: A temporary layoff is some time off at a
partial wage—a partially paid vacation.
o Firms: the attractiveness of a temporary layoff
depends on the extent of experience rating.
o Absent experience rating, the firm pays nothing
when a worker is temporarily laid off.
• Studies suggest that partial experience rating alone
can account for 21–33% of all temporary layoffs in the
United States.
14.4
The “Benefits” of Partial Experience Rating
• Having a fully experience-rated system would “hit

firms while they are down:” just when firms have laid
off the most workers, their taxes would increase the
most.
• By having partial experience rating, UI programs
systematically subsidize high-layoff firms.
14.4
APPLICATION: The “Cash Cow” of Partial
Experience Rating
• United States is unusual in having any experience

rating.
• In Canada, workers have to work only 10 weeks to
qualify for 42 weeks of UI with a replacement rate of
60%.
• This system is easy to exploit.
• You and four friends are considering buying a fishing
boat, with each of you working 10 weeks out of the
year, for a total of 50 weeks.
14.4
APPLICATION: The “Cash Cow” of Partial
Experience Rating
• You and four friends buy a fishing boat, each working

10 weeks, for a total of 50 weeks.
• Each of you would report earning $800 per week for
the 10 weeks worked and then report being laid off.
• You would each receive $20,160 of UI during the rest
of the year. Total UI benefits exceed $100,000, for
only $40,000 of work.
• UI is not simply a system of insurance against true
unemployment risk in Canada, but also a large
government transfer to inefficient firms and their laid-
off workers.
14.4
Workers’ Compensation and Firms
• With WC, firms and workers can get together to

increase “injuries” if the insurance is less than fully
experience-rated.
• Firms have less incentive to invest in safety when
there is no-fault insurance for injuries.
14.5
Implications for Program Reform
• Benefits Generosity
o Benefits should be highest for DI and lowest for
WC, with UI in the middle.
o But WC is the most generous.
• Targeting
o Target UI benefits toward those who have been
permanently laid off.
o Pay higher DI/WC benefits to people with less
ambiguous disabilities or injuries.
14.5
Implications for Program Reform
• Experience Rating
o Fuller experience rating would do more to put
inefficient firms out of business than to hurt firms
that are fundamentally sound but having a
downturn.
• Worker Self-Insurance?
o The government could replace payroll taxes and
mandated WC insurance with individual “social
insurance savings accounts,” to which workers
would contribute some fixed amount.
14.5
APPLICATION: Reforming UI
• Worker self-insurance for UI would share the benefits

and costs of a privatized Social Security system:
o By making unemployed or injured workers pay for
their income support out of their own savings
accounts, the program would minimize moral
hazard.
o A UI payroll tax of 4% invested in such accounts
could cover the costs of unemployment spells for
virtually all workers.
14.5
APPLICATION: Reforming UI
Reemployment earnings insurance:

• Self-insurance for unemployment. Savings, with
government loans available.
o Loan forgiveness for low-wage /long-term
unemployed.
• Wage insurance. If you take a lower-paying job, you
get a transfer equal to 25% of the wage cut.
• Net result: lower moral hazard, redistribution to both
low-wage workers and to workers suffering a large
wage loss.
14.6
Conclusion
• Individuals clearly value the consumption smoothing

provided by social insurance programs.
• In each case there are significant moral hazard costs
associated with the provision of the insurance.
• Empirical analyses of all three programs can be used to
inform policy makers’ decisions as program reforms
move forward.

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Public Finance and Public Policy Jonathan

• Unemployment insurance, workers’ compensation,

• Unemployment insurance: A federally mandated,

• Benefits depend on weekly earnings.

• Disability insurance: A federal program in which a

Workers’ Compensation provides no-fault insurance.

• These programs have distinct time patterns, paying

• There is relatively little evidence on the consumption-

• Meyer (1989) studied how New Jersey’s increase in

Do longer durations represent an undesirable outcome?

Gruber (2000) studied Canada’s DI system:

Krueger (1990, 1991) studied a benefit increase in MN:

• Partial Experience Rating Subsidizes Layoffs

• Having a fully experience-rated system would “hit

• United States is unusual in having any experience

• You and four friends buy a fishing boat, each working

• With WC, firms and workers can get together to

• Worker self-insurance for UI would share the benefits

Reemployment earnings insurance:

• Individuals clearly value the consumption smoothing

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