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How to Avoid the Coming Economic Cliff

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How to Avoid the Coming Economic Cliff

July 17, 2020

At the end of this month, the CARES Act bonus payment of $600 per week for unemployment insurance recipients will expire. Despite broad consensus among policymakers that something needs to be done, there is a sharp divide over what that should be. While congressional Democrats are keen on extending the current program to leave the $600 weekly bonus in place, leaders in the GOP, including Senate Majority Leader Mitch McConnell and President Trump, are pushing for a different solution: a return-to-work bonus. Unfortunately, neither idea is the best solution to help many out of work Americans. A better plan lies somewhere in the less-news-cycle-worthy middle ground.

The CARES act initially created the $600 federally paid bonus for state unemployment insurance programs because we urgently needed to get money into the hands of the massive number of people who were laid off in the initial months of the crisis to avoid a tragic drop in consumer spending. That plan worked reasonably well in the short-run; we even saw disposable income increase in May despite the ongoing economic crisis. But leaving that program in place would create challenges that would eventually hamper the economic recovery. The problem is that the flat $600 bonus on top of the usual state unemployment insurance payment has left some workers taking home more from unemployment insurance than they were earning on their job. Workers in these circumstances might prefer to stay unemployed even when work becomes available to them. That justifiable hesitance to return to work will eventually create a drag on the economic recovery once employers begin wanting to hire new workers, whenever that may be. According to new research, as many as two-thirds of unemployed workers are taking home more money each week now than they were when they were employed. This is a great outcome for those workers, in the short run, but may make it hard for some businesses to find workers when they are ready to come back to work in person after the shutdown. Some that have continued to operate throughout the pandemic have already reported challenges in finding workers because they don’t pay wages that can compete with the benefits available through unemployment insurance. 

The GOP is more optimistic about the potential pace of economic recovery. They may let the current UI program expire and there’s no word on a plan to make it work better if it does stay. But they are proposing a new program to counteract its effects; the back-to-work bonus. The idea is that paying people who choose to go back to work will offset the disincentive to work that’s created by the $600 weekly unemployment insurance bonus. That makes some sense, but it falls short of being the ideal solution because many people won’t have the option to go back to work. 

Rather than spending money to compete with the disincentive to work created by the unemployment insurance bonus, the GOP should be advocating that we fix the fundamental problem of benefits being more generous than compensation from work. Once that’s been done, a return to work bonus might be a fine additional measure to promote a recovery. However, to the extent that employers don’t want to hire, the bonus program won’t make much of a difference in job creation. Helping the unemployed who have no job to return to should be the top priority. 

There are a number of ways to reform the program to supplement unemployment insurance benefits that meet these criteria. 

State unemployment benefit programs vary on many dimensions but can generally be described as replacing some percentage of a worker’s previous level of income. Prior to the federal intervention of the CARES act program, workers nationally were getting 40–50 percent of their wages “replaced” by unemployment insurance benefits. Rather than extending the flat $600 federal subsidy to unemployment recipients, a revised program could instead offer an increase in the replacement rate relative to the one typically offered by the state. The challenge with this style of program, unfortunately, is that it would be challenging for states to implement, especially on short notice. Reportedly, states have struggled to update their computing systems to deal with a federally mandated revision in benefit eligibility.

Until administrative capacity at state unemployment insurance program offices improves sufficiently to implement a sophisticated solution, another stopgap measure may be necessary. In that case, simply reducing the flat bonus from $600 to something less than $600 would offer an improvement. There’s no correct amount and it may vary by state, so any decision amount that’s chosen would be the product of a political rather than a policy-oriented negotiation. But one recommendation, to lower the sum to $500, which would at least meet the goal of replacing just 100 percent of lost income on average, is a reasonable one. That would at least lessen the extent to which the disincentive to work could constrain our recovery and could set the stage for progressive steps to lower the amount as the crisis progresses. If this option is exercised, efforts to improve state unemployment insurance computing systems should occur in parallel to ensure that more sophisticated solutions can be implemented as we progress through this crisis or even in advance of future disruptions to the economy requiring intervention. 

Another option would be to extend the flat benefit (at the original, lower amount) and ask states to cap the benefit delivered to workers at a determined replacement rate that’s less than 100 percent. Allowing states to share in the savings generated by that cap could give them both the resources to upgrade their computing systems as necessary and the incentive to do so. Even with this option, lawmakers should be imagining an exit plan from this approach, whether it be a more sophisticated subsidy program or a stepdown schedule for the flat subsidy amount, perhaps pegged to markers of economic activity, like the state unemployment rate.

Unfortunately, the economic fallout from the COVID-19 pandemic has only just begun, and with case counts rising in regions across the country we may have the worst of both the health and economic crises still to come. The federal government should sit ready to act and spend generously as the circumstances merit. Right now, that means replacing the initial unemployment insurance bonus with an alternative that lessens the unintended disincentive to work while avoiding the temptation to pile on new policies that only further skew incentives without even delivering dollars to those who need them the most.

Beth Akers is a senior fellow at the Manhattan Institute and a former Council of Economic Advisors economist. Follow her on Twitter here.

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