Could Unemployment Benefits cause further Unemployment?

The Former Treasury Secretary Henry Paulson in an interview with Good Morning America in February this year said that the economy is well on its path to recovery. ‘The Economist’ in July suggested that the recession may well have ended last year. Either way, we appear to be making a slow but steady climb out of the biggest recession since the Great Depression of the 1930’s. This climb out of the recession is primarily reflected in terms of the positive GDP growth rate, which was -6.8% in December 2008; with the 2008 average being -2.73%. The 2010 average currently stands at 3.05%, with a 5.6% growth in the last quarter.; the fastest growth rate in 6 years.

How is this positive change reflected in the employment?

Following the report that was released by the Federal Census Bureau earlier this month, 131,000 jobs were lost in July 2010. Both the number of discouraged workers and the length of unemployment have steadily increased in the past year and continued to rise between June- July 2010.

After the collapse of some of the most established financial institutions like Freddie Mae and Fannie Mac, Lehman Brothers, Bear Stearns and AIG, one of the biggest characteristics of the current recession was the mass lay-offs. The trouble in the financial sector created a domino effect as unemployment spread across every imaginable field. People chose to go back to school, were forced to be self-employed, or hold temporary jobs for the lack of a better alternative. Better yet, they sought unemployment benefits.

Unemployment, under its current definition requires the job seeker to be able to work and to be actively looking for work. Unemployment benefits thus only extend to the unemployed while he is looking for a new job. Currently only 14% of projected wages are replaced with unemployment benefits in the US1. Compared to the figures of Italy (34), France (39), and Netherlands (53), this figure does indeed seem very low.

Unemployment benefits were to be revaluated from the original 26 weeks of benefits US, per state determinations for Emergency Unemployment Compensation (EUC). Unemployment benefits in NY State are now 97 weeks.

Lets look at some of the European examples to understand the effect of increased unemployment benefits.

Interestingly, there is a direct correlation between unemployment benefits and taxation rates. Europe has some of the highest taxation rates, and some of the highest unemployment rates. In 2002, a regular financial year, the average length of unemployment in the US was 4.4 months. The length of unemployment in France was 12.8 months, Switzerland was 14 months, and Czech Republic experienced unemployment for close to 21 months.

Taxation rates are the highest in Sweden, with 31% on income being taxable at the lowest income bracket, and 56% taxable at the highest.

Unemployment benefits are extended for 60 weeks in Sweden and unemployment has averaged at over 7%.

The UK is known to have a taxation rate of over 20% for income, and 10% for any saving over £2400. It also has the highest historical rate of voluntary unemployment.

So, could people voluntarily stay unemployed when unemployment benefits are extended? There could be several reasons why the answer could be yes. The reasons for choosing to be unemployed include taxation rates. Why work when you could make the same amount in employment benefits after your income is taxed? This opportunity cost between that lets them earn a small fraction lower than their original income and stay out of the work force.

Thanks to Flickr for the picture.