Unemployment Insurance - More Tax for More Unemployment

Dr David Law
Insights Newsletter
12 November, 2021

In May, Budget 2021 revealed that work was underway to develop an unemployment insurance scheme. This would see benefits tied to past employment and wages in some way, and those benefits would be generous compared to the status quo.

Six months on we know nothing more about the scheme. This week, however, The New Zealand Initiative released a report “Unemployment Insurance: A recipe for more unemployment?” that foreshadows what the consequences might be if unemployment insurance were introduced in New Zealand.

For a start, it is not immediately clear there is a problem for unemployment insurance to solve.

Our welfare system is very well targeted by international standards, directing help to those who need it most.

New Zealand has relatively low levels of unemployment. From 2000 to 2020, New Zealand’s average annual rate of unemployment was 5%, compared to 6.9% for the OECD.

Furthermore, long-term unemployment, that is, people who have been unemployed for 12 months or more, is also very low in New Zealand. From 2000 to 2020, New Zealand’s average annual share of long-term unemployment in total unemployment was 11.8%, compared to 29.4% for the OECD.

Unemployment insurance would put these outcomes at risk and come at significant cost. For advanced economies, the total of worker and employer contributions ranges from around 1% of total payroll in Japan to as much as 8% in Denmark.

Although the cost of such a scheme in New Zealand may start off low since unemployment is now only 3.4%, as perverse labour market incentives begin to bite, expect the cost to increase. The average cost of UI for advanced economies is 2.6% of total payroll. But many of those schemes are less generous than the one proposed by our government.

Indeed, with 80% of past wages replaced by unemployment insurance benefits, the establishment of such a scheme would discourage workers from seeking new employment when out of work. There is a large body of international evidence that suggests unemployment insurance leads to higher levels of unemployment, with people remaining unemployed for longer.

Once governments introduce unemployment insurance schemes, they are very difficult to unwind. Even those who do not draw on the scheme may feel they have built entitlements through years of contributions, whether those entitlements are explicit or not.

What is more likely is that the scheme would grow over time to encompass a wider array of benefits to meet other social objectives. Healthcare, disability, old-age care, and pensions are also often covered by social insurance. Average social security contribution taxes which fund social insurance programmes are approximately 8% of GDP in the OECD. Are we sure this is a path we want to take?

Stay in the loop: Subscribe to updates