Unemployment insurance creates more problems than solutions

Roger Partridge
NZ Herald
8 February, 2022

Since last week’s announcement, Finance Minister Grant Robertson’s proposed social unemployment insurance has been criticised across the political divide. Some complaints relate simply to timing. “A decent scheme at a bad time,” was a common assessment. With many firms reeling from pandemic-related restrictions and others from supply constraints and spiralling inflation, this must have come as no surprise to the Minister of Finance.

But much of the criticism was more trenchant. The left-wing blog site “No Right Turn” accused the Government of “throw[ing] the poor under the bus.” The blog’s author described the scheme as “generous for the rich and the middle classes, and outright brutal for the plebs in poorly-paying jobs or on short-term contracts, who will pay and pay and never see anything.” The Child Poverty Action Group said the plan is “likely to be regressive and would bake in existing inequities.”

On the political right, National’s leader, Christopher Luxon, described the scheme as a “jobs tax” and a “solution looking for a problem.”

A new, compulsory welfare scheme like Robertson’s was always going to be controversial. This means the debate must step above the politics and focus on the evidence. As with any reform proposal, there are two principal questions. Is there an identifiable problem that needs to be solved? And does the evidence support the proposed solution?

On each question, research from my colleagues at The New Zealand Initiative suggests the answer is, “No.”

Robertson’s proposal involves an ACC-style compulsory social insurance scheme for workers who lose their jobs or cannot work due to long-term sickness or disability.

Workers laid off or who are forced to stop working on health grounds will receive 80% of their usual salary for up to seven months. Payments will be subject to the same salary cap as earnings-related compensation under ACC. Employers will be liable for the first four weeks’ payments, with the scheme then providing cover for a further six months.

As with ACC, a dedicated tax (described in the 178-page discussion document accompanying Robertson’s announcement as a “levy”) will pay for the scheme. The discussion document estimates the costs to be covered by this levy at $3.54 billion or just under 3% of workers’ incomes. The levy will be split equally between firms and workers. A worker on a salary of $100,000 will pay $1,385, matched by an equal payment from her employer.

Solution or problem?

Unemployment insurance sounds like a nice-to-have. But as the New Zealand Initiative explained in our 2021 research note, Unemployment Insurance: A recipe for more unemployment?, Robertson’s proposed unemployment insurance scheme does not solve an identified problem.

The Minister’s discussion document sets out three aims. To minimise the financial impact of workers losing their jobs. To help workers get back to good jobs. And to support the economy during shocks.

These are all worthy objectives. Yet OECD studies show that New Zealand’s welfare system is already well-targeted by international standards. Comparing OECD countries, our welfare system stands out as the most effective at transferring welfare from high-income households to low-income households.

More importantly, New Zealand’s unemployment rate is consistently among the lowest in the OECD, thanks to well-functioning labour markets. And when it comes to long-term unemployment, that is, those who have been unemployed for 12 months or more, New Zealand’s record is even better. Over the last two decades, the long-term unemployed made up only 11.9% of total unemployment in New Zealand. This compares with 29.4% for the OECD – and 44% for the EU.

With a well-functioning welfare system and the labour market producing comparatively good outcomes, there appear few good reasons for imposing the costs of an expensive new layer of welfare onto firms and workers.

The perils of unemployment insurance

Unemployment insurance also brings perils. First, there is the cost itself. $3.5 billion is quite a bill for insurance most workers have chosen not to buy for themselves. And the $3.5 billion price tag is simply an estimate. In the way of these things, the actual cost will almost inevitably be higher.

Proponents of unemployment insurance argue that it allows those laid off a better opportunity to search for and secure good jobs. Without it, they may be forced to accept lower-quality work, resulting in lower wages than might otherwise have been the case. This process is known as “wage scarring.” However, opponents of unemployment insurance point to the risks of workers’ skills deteriorating the longer they spend unemployed.

The economic evidence on the trade-off in these effects is limited. However, a 2016 study published in the Annual Review of Economics by Johannes Schmeider and Till von Wachter, The Effects of Unemployment Insurance Benefits: New Evidence and Interpretation, suggests unemployment insurance has a slight net negative effect on wages.

More tax for more unemployment

But the bigger peril is increased unemployment. And here the case against unemployment insurance is strongest. A long-standing body of empirical research shows that unemployment insurance increases unemployment.

The reasons for this are easily understood. If the welfare system increases the generosity of unemployment benefits, the incentives for those to seek work are relaxed. And international experience reveals the opportunities to game social unemployment insurance schemes are almost endless. More unemployment is the outcome.

Scope creep

In his December 2021 Herald column, Social Insurance lessons from Germany, New Zealand Initiative executive director Dr Oliver Hartwich explains that scope creep is another problem with unemployment insurance. From modest beginnings, the cost of Germany’s social insurance scheme contributes to the average German worker paying 40% more tax than her Kiwi equivalent.

Robertson’s unemployment insurance scheme has mushroomed even during its conception. The scheme was publicly foreshadowed in the May 2021 budget. But it traces its origins back to the 2018 Future of Work Tripartite Forum comprising the Government, The New Zealand Council of Trade Unions and Business New Zealand.

When initially proposed, business groups expected it to be restricted to redundancy and to be “revenue neutral.” In other words, unemployment insurance costs were to replace redundancy costs and leave firms no worse off.

But as the saying goes, an elephant is a mouse built to government specifications. In the same way, the scheme as announced by Robertson provides insurance not simply against workers being made redundant but also against loss of income from sickness or disability. A scheme envisaged as cost-neutral is now a multi-billion-dollar compulsory health insurance scheme.

Little wonder that Employers and Manufacturers Association chief executive Brett O’Riley was quick to distance his organisation from Robertson’s proposal. “No support for the Income Insurance Scheme as is,” said the EMA’s press release on the day of Robertson’s announcement. “[O]ur involvement in the development of this was on the proviso that it was cost-neutral and would be balanced by reducing liabilities for business elsewhere.”

Health extension not justified

Extending ACC to cover sickness-related absences from work has been mooted for decades. After all, what is the difference between a worker unable to work due to injury and one unable to work because of illness? Yet the injured person receives earnings-related compensation from ACC while, unless privately insured, the unwell person must rely on much less generous support from the welfare system. Robertson’s proposed scheme would solve this apparent anomaly.

However, the apparent similarity hides a critical difference. ACC solves an intractable problem with injuries – the high transactions cost of assessing fault and damages through the courts when a worker is injured. ACC’s no-fault approach bypasses this problem. In contrast, the judicial system is not involved in attributing fault for sickness or disability. This difference removes the justification for imposing ACC-style compulsory insurance for health and disability.

Perhaps recognising this difference, the discussion document raises a separate but weaker problem with private insurance markets. As many as one-in-six New Zealand households have private income protection insurance, providing ACC-like cover from loss of earnings from sickness or disability. But insurance markets suffer from the problem of “adverse selection.” Higher risk individuals are more inclined to purchase this type of insurance, pushing up its cost. Making employment insurance compulsory could solve this adverse selection problem. Yet it would do this at the expense of forcing workers to take out insurance they would not choose to take out for themselves. This is hardly a convincing justification.

On closer inspection, Robertson’s social unemployment insurance is not very social. It is more welfare than insurance. Its levy is really a tax. It creates more problems than it solves.

In short, this is not a good idea at a bad time. It is a bad idea at the worst possible time. And if the promised “consultation” on the Minister’s discussion document does not come to that conclusion, there will have been something wrong with the consultation.


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