Unemployment Insurance

views updated May 23 2018

Unemployment Insurance


Unemployment insurance is a program of social insurance designed to compensate workers for part of the wage loss caused by involuntary joblessness. Weekly benefits are paid to eligible workers as a matter of right, according to benefit schedules or formulas stipulated in the law. Benefit eligibility and amounts are related to previous contributions by or on behalf of the worker.

In addition to the primary purpose of providing employees with a measure of economic security through wage-loss compensation, unemployment insurance helps to cushion economic slumps by supplying consumer purchasing power. It can therefore serve as an important “automatic economic stabilizer.” Also, unemployment insurance may preserve work skills and training by reducing pressures on the unemployed to accept lower-level jobs, and it may provide additional incentive, through differentiated employer taxes, for managements to regularize their employment.

Methods . Most national systems of unemployment insurance are compulsory, in the sense that coverage is required by law and the taxing power is used for financing benefits. In the Scandinavian countries the program consists of funds voluntarily organized and administered by trade unions and subsidized by the state from tax monies.

The United States has a federal-state program. Essentially the federal government, under the Social Security Act of 1935, forced the states to enact programs of unemployment insurance by levying an unemployment tax on employers and offering to pay the full cost of administration of a state program approved under the terms of the federal act. The federal unemployment tax on employers’ payrolls is subject to 90 per cent offset (1) for employer payments of state payroll taxes for unemployment benefits or (2) for reductions in or exemptions from such a state tax under a program of experience rating. Thus, each state is free to determine its own benefit level and duration and its own tax rates under company-by-company experience rating based on benefits or layoffs charged to individual employers; benefit provisions and tax rates differ widely among the states.

In addition to the federal-state program, there is a separate national unemployment insurance system for railroad employees. That system is financed by a uniform federal tax on all the carriers and has a single, nationwide benefit schedule.

Under the state laws, unemployment benefits are related to previous earnings. An individual’s eligibility for benefits will depend on his total earnings or weeks of work in a base year. The amount of his weekly benefit and, in most states, the number of weeks that he can draw benefits will vary with his base-year earnings or work experience. Relating wages to previous earnings tends to restrict coverage and limits total claims on a state’s fund.

Historical development. Generally, unemployment has been the last major economic risk of workers to be covered by social insurance. Programs on a national scale began with state subsidies to voluntary schemes in France (in 1905), Norway (in 1906), and Denmark (in 1907). The first national law establishing a compulsory program on a country-wide basis was enacted by Great Britain in 1911. The second was enacted by Italy in 1919. Germany adopted a compulsory program in 1927, Japan in 1947, and Canada in 1955. As previously noted, the federal-state system in the United States started with passage of the Social Security Act in 1935, and by mid-1937 all states had enacted unemployment insurance laws complying with the provisions of the federal act.

Issues. Disagreement concerning objectives, mechanisms, and effects helps to explain the delayed development of unemployment insurance programs. Sharp differences of opinion have arisen on a number of issues.

Both individual and total unemployment are unpredictable, yet they are subject to various influences and controls. Government monetary, fiscal, and foreign-trade policies affect the volume of unemployment. It is also claimed that workers and managements are, in some measure, responsible for joblessness. Unemployment benefits may have an impact on wage levels and on worker incentives and mobility. Tests of availability for work and of willingness to accept a suitable job present practical difficulties. For such reasons, unemployment has not seemed to be a risk suitable for private underwriting, and no insurance company has sought such business.

The chief controversies in unemployment insurance have centered around five issues: (1) How much should the insurance purpose of wage-loss compensation be modified by considerations of worker needs and incentives? (2) What are “adequate” benefits? (3) How should the program be financed, and to what extent should a concept of blame or responsibility influence the financial arrangements? (4) What restrictions on worker coverage, benefit eligibility, and benefit disqualification are necessary in order to maintain the integrity of the program? (5) Are separate state and industry programs preferable to a single, national program?

The different aspects of unemployment insurance (coverage, benefit level and duration, eligibility, disqualifications, financing, and level of policy determination) are interrelated parts of a coordinated scheme. Flat benefits go with flat contributions; liberal benefits stimulate restricted eligibility and severe disqualifications. Views on any aspect of the program are affected by one’s conception of the purposes of unemployment insurance and one’s philosophy of economics and of government. Therefore, in discussing the five policy issues, it is necessary to bear in mind the interconnections between the parts and their relation to a general economic philosophy.

Insurance versus need. Whether the program should be strictly one of compensation for wage loss from short-term joblessness or should make allowance for need factors (family size, cost of living, difficulty of re-employment, training needs, etc.) is a basic philosophical issue in unemployment insurance. Generally, under the state laws, weekly benefit amounts vary directly with the individual’s previous earnings.

Organized labor in the United States has strongly supported benefit levels varying with regular wage differentials and benefit ceilings sufficiently high so that only a minor fraction of the beneficiaries would have a flat benefit rate at the ceiling level. However, there has been strong sentiment in some unions for dependents’ allowances, which would mean that workers with the same wage record would receive different benefits, depending on family size. With respect to benefit duration, important elements in organized labor have tended to stress needs rather than earnings. They have favored uniform duration regardless of the individual’s total previous earnings or length of employment and have supported ad hoc 50 per cent extensions of duration in periods of heavy long-term unemployment.

Generally, business management in the United States has stressed maintenance of the insurance principle and avoidance of any mixing of unemployment insurance and unemployment relief based on individual and family need. However, some elements in management have favored a minimum program with relatively low benefit ceilings, in order to limit costs and to restrict the role of unemployment insurance to a subsistence minimum. The result would be flat or uniform benefits for most recipients, not benefits compensating in proportion to wage loss. Also, there has been some management sentiment for relating benefits to the individual’s net (after taxes and other deductions) pay rather than his gross earnings.

Modification of the insurance principle by considerations of beneficiaries’ needs may take other forms. Some state laws provide continued and additional duration of benefits for jobless workers who are participating in an approved training program, during which they may not be available for work and, therefore, are not involuntarily unemployed. At times some sentiment has existed to make the performance of public work a condition for continued receipt of unemployment benefits—at least for some workers under extended benefit programs, such as those in the United States in 1958-1959 and 1961-1962. This would involve a mixture of unemployment insurance and work relief.

Adequacy of benefits. No consensus exists with respect to the criteria for adequacy of benefit levels or duration. One suggested test is that benefits should be sufficiently large to enable workers to meet all nondeferrable expenses for necessities (variously defined) throughout the period of their unemployment. Despite special studies in six states, this test has proved difficult to quantify.

A frequently mentioned standard for weekly benefits is 50 per cent of gross weekly pay. Because of the restrictive effects of low benefit ceilings, the average rate of compensation in the United States has been around 40 per cent. Incomplete coverage, waiting periods, benefit disqualifications, nonfiling by eligibles, and exhaustion of benefit rights have resulted in a percentage of wage-loss replacement for total unemployment of about 20 per cent for the country as a whole. For purposes of economic stabilization the percentage should be considerably larger. This is especially true in view of the fact that, by and large, recession unemployment is compensated at no higher rate than nonrecession joblessness.

Supplemental unemployment benefits negotiated under collective bargaining in such high-wage industries as auto, steel, and rubber have established a standard of 65 per cent of net pay, which averages perhaps 55 per cent of gross pay. Experience indicates that for heads of households benefits would need to be much closer to 100 per cent of net pay in order to have significant adverse effects on incentives to work.

The duration of benefits raises the question of the types of unemployment that the insurance program is designed to meet. Although complete agreement is lacking, most students of the subject would limit benefits for one period of unemployment to between 26 and 39 weeks. This is not only for cost reasons but also because of the need for re-examination of the recipient’s case and his possible readjustment in order to avoid the debilitating effects of extended benefits as a matter of right. Of course, pressures build up for special extension of benefits in periods of heavy unemployment, in the absence of a satisfactory program of unemployment relief and proper arrangements for worker retraining and relocation. In the United States, benefit duration under the state laws has been lengthening to an average of about 25 weeks as long-term unemployment has become more serious. In some negotiated plans for supplemental unemployment benefits, benefit duration is 52 weeks, as it is under the national program in Canada.

Financing. In almost all countries, unemployment insurance is financed by equal employer and employee contributions, with either a contribution by the state or some state subvention for administrative costs. In the United States, however, in all except three states, taxes levied on the employer’s payroll meet the full cost of benefits and administration.

Vague notions about the causes of unemployment, of possible preventive action by individual employers, and of allocation of the benefit costs according to responsibility lie behind sole reliance on employer taxes under experience rating in the United States. In addition, complete reliance on employer contributions permits employees to escape any personal income tax on income used for social insurance contributions.

Experience rating of individual employers for tax purposes gives each employer a direct interest in the denial of benefits to his former employees because in most states he can thereby make a tax saving. Such employer interest, it is claimed, helps to prevent abuse.

Under experience rating some employers are completely exempt from the state tax in one-fourth of the states because of their favorable employment or benefit records, and in some twenty other states many firms are taxed at a rate 10 to 30 times that applied to employers on the most favorable rate. Since many competing employers are likely to be at both the minimum rate and the maximum rate, the bulk of the incidence of the state taxes appears to rest on the employer.

In most states, experience rating results in the rising or falling of tax rates as total benefits increase or decline, with a year’s lag. That tends to accentuate the business cycle. In addition, the most favorable tax rate can be acquired by an employer who contracts his employment through normal attrition, whereas with a rapidly expanding labor force and high unemployment levels, it would seem desirable to reward expansion in employment and especially in the hiring of disadvantaged workers.

Coverage, eligibility, disqualifications. Unemployment insurance is faced with several difficult problems of administration and definition. In addition to their technical aspects, such problems involve questions of social insurance philosophy. A strict insurance viewpoint may result in more restricted coverage and tighter eligibility requirements than in stress on need for benefit protection.

Particularly where the tax is levied completely on the employer, small businesses with two or three employees and nonprofit institutions of all sorts may resist inclusion in coverage. In addition, administrative difficulties may preclude inclusion of migratory farm workers and other casual labor. Nevertheless, coverage has tended to expand gradually.

Benefit eligibility involves problems of defining “regular” attachment to the labor market and “involuntary unemployment.” There is, for instance, a question whether short-season workers should be eligible for benefits when they are jobless during the off-season. Under state laws, eligibility is defined in terms of qualifying wages or weeks of employment; either way, it usually means that it takes 14 to 20 weeks of covered employment to qualify. In some states, the receipt of other employee benefits (i.e., a pension, dismissal compensation, or workmen’s compensation) may render a worker ineligible or reduce his unemployment benefit accordingly. In addition, in order to draw benefits a worker must be registered at a public employment office and be available for work.

Although the states have not increased their wage qualifications as rapidly as earnings have risen, benefit disqualifications have been tightened considerably. Levy of the full tax on the employer and the allocation of benefits to particular employers under experience rating have been largely responsible for that development. An unemployed worker who is discharged for misconduct, or who (in about half the states) voluntarily quits, even for good personal or economic reasons, or who refuses a job offer considered suitable will have his benefits postponed, reduced, or canceled. The nature of the penalty and the restriction of good cause for leaving to employer responsibility have reduced benefit eligibility.

Decentralized versus national systems. Most countries have a single, national system with nationwide pooling of reserves. In Scandinavia, the Netherlands, and Switzerland there are separate regional, industrial, or occupational funds.

In the United States the existence of separate state systems encourages interstate competition for industry through low benefits, severe disqualifications, and the resulting low tax rates. Some states offer a worker with a particular wage record twice as much in total benefits as other states do. In addition, the incidence of unemployment by states is quite uneven, with the low-benefit states also being the low-unemployment states.

The arguments for separate state unemployment programs are in terms of the maintenance of state functions under a federal system of government, the advantages of state experimentation, and the desirability of decentralization and adaptation to local or regional conditions. Fear exists that centralization of policy determination may lead to inflexible uniformity and national use of unemployment insurance for political purposes.

Clearly, there is need for thorough analyses of experience in various countries to determine the validity of different assumptions and reasoning about unemployment insurance. Resources devoted to independent research on the subject are most meager compared with total expenditures.

In view of marked differences in financial burdens and the precarious position some state funds have been in, a mechanism for broader sharing of the risk seems highly desirable in the United States. If unemployment insurance is to play an important role as an automatic stabilizer, more stress must be placed on national economic interests in the program. That may mean some type of federal standards for benefit levels and some national sharing of the extraordinary costs of recession unemployment in particular states.

Richard A. Lester


Current data and reports on unemployment insurance may be found in the following periodical publications: U.S. Bureau of Employment Security, Comparison of State Unemployment Insurance Laws; Unemployment Insurance Review; U.S. Unemployment Insurance Service, Unemployment Insurance Statistics.

Becker, Joseph M. 1953 The Problem of Abuse in Unemployment Benefits: A Study in Limits. New York: Columbia Univ. Press.

Becker, Joseph M. (editor) 1965 In Aid of the Unemployed. Baltimore: Johns Hopkins Press. → See especially pages 63-78, “Unemployment Insurance: Risks Covered and Their Financing,” by Merrill G. Murray; pages 79-111, “The Adequacy of Benefits in Unemployment Insurance,” by Joseph M. Becker; pages 112-136, “Supplementary Unemployment Benefits,” by Joseph M. Becker and V. K. Boman.

Burns, Eveline M. 1956 Social Security and Public Policy. New York: McGraw-Hill.

Haber, William; and Murray, Merrill G. 1966 Unemployment Insurance in the American Economy: An Historical Review and Analysis. Homewood, III.: Irwin.

Lester, Richard A. 1960 The Economic Significance of Unemployment Compensation, 1948-1959. Review of Economics and Statistics 42:349-372.

Princeton University, Industrial Relations Section 1962 The Economics of Unemployment Compensation, by Richard A. Lester. Research Reports, Series No. 101. Princeton, N.J.: The University, Industrial Relations Section.

Unemployment Insurance Review.→ Published since 1964.

U.S. Bureau of Employment SecurityComparison of State Unemployment Insurance Laws.→ Published since 1948.

U.S. Social Security Administration, Office of Program Research 1967 Social Security Programs Throughout the World. Washington: Government Printing Office.

U.S. Unemployment Insurance ServiceUnemployment Insurance Statistics.→ Published since 1964.

Wermel, Michael T.; and Beideman, Geraldine M. 1957 Supplemental Unemployment Benefit Plans: Their Economic and Industrial Relations Implications. California Institute of Technology, Benefits and Insurance Research Center, Publication No. 4. Pasadena, Calif.: The Institute, Industrial Relations Section.

Unemployment Compensation

views updated May 17 2018


Insurance benefits paid by the state or federal government to individuals who are involuntarily out of work in order to provide them with necessities, such as food, clothing, and shelter.

Unemployment compensation for U.S. workers was established by the federal social security act of 1935 (42 U.S.C.A. §§ 301 et seq.). Unemployment insurance provides work-ers who have lost their job through no fault of their own with monetary payments for a given period of time or until they find a new job. This compensation is designed to give an unemployed worker time to find a new job equivalent to the one lost without major financial distress. Unemployment compensation is also justified as a way to provide the U.S. economy with consumer spending during an economic downturn.

The mass unemployment during the Great Depression of the 1930s led to the enactment of the federal unemployment compensation law. States had resisted establishing their own unemployment compensation plans because the first states to tax employers to fund such a plan would lose business and jobs to other states. Therefore, a federal program was needed. Much of the federal plan was implemented under the Federal Unemployment Tax Act of 1935 (26 U.S.C.A. §§ 3301 et seq.). In 1938, Congress enacted the Railroad Unemployment Insurance Act (42 U.S.C.A. §§ 351 et seq.), which provides unemployment compensation for railroad workers who lose their jobs.

A combination of federal and state taxes is levied on employers to fund state-administered programs that meet minimum federal standards. Federal funds are also used for administrative costs and to set up employment offices that attempt to match workers with new jobs. In 2000, approximately 125 million individuals, or 97 percent of all wage earners, were covered by unemployment compensation programs. During that same year, an average of 38 percent of unemployed individuals were receiving some sort of unemployment benefits.

In general, a tax on employers provides the funds to pay unemployment compensation. An employer who has more than a specified minimum number of employees is ordinarily required to file regular reports that disclose the number of employees and the amount of their wages, including tips. A standard or basic rate is charged against the employer based on the amount of wages paid. If the employer does not lay off employees, the employer will be entitled to a credit. An employer's record is unaffected if an employee quits or is discharged for good cause. An employer of eight or more persons is permitted to subtract what he pays to the state unemployment compensation fund from his federal unemployment tax.

Each state establishes which employers are obligated to pay state unemployment taxes. Ordinarily a state will require payment of the tax from every individual, partnership, or corporation that pays wages to a specified minimum number of people to do work. Certain types of employment are excluded from mandated coverage, including some agricultural labor, some charitable or nonprofit work, and some government work.

Any individual who qualifies under the terms of the state unemployment compensation law is entitled to collect benefits. To be eligible, an individual must have worked for a certain minimum number of weeks and earned wages in at least the amount set by state law. Certain states will pay reduced benefits where part-time work provides only a small amount of money. Individuals who are self-employed are not entitled to unemployment compensation

A state may not discriminate because of gender or religious beliefs in the awarding of unemployment compensation. In Wimberly v. Labor and Industrial Relations Commission, 479 U.S. 511, 107 S. Ct. 821, 93 L. Ed. 2d 909 (1987), the U.S. Supreme Court ruled that no person may be denied compensation solely on the basis of pregnancy or the termination of pregnancy. The Court, in Hobbie v. Unemployment Appeals Commission, 480 U.S. 136, 107 S. Ct. 1046, 94 L. Ed. 2d 190 (1987), held that a state may not deny unemployment benefits to a worker who is discharged for refusing to work because of religious beliefs that he or she adopted after becoming employed.

Unemployment compensation is paid for a certain number of weeks. However, during economic recessions the federal government has provided emergency assistance to allow states to extend the time during which individuals can receive benefits. The states are allowed to use money they have deposited in special accounts of the federal Unemployment Trust Fund. For a state to use this emergency benefit system, the unemployment rate usually must reach a designated percentage within the state or the country.

An unemployed worker is not required to submit proof that he needs money or that he has no other means of support. Anyone who qualifies has a right to collect benefits because payments are designed to replace part of the wages lost during temporary periods of unemployment. Severance pay does not necessarily preclude payment of benefits, but some state laws treat it as earnings for the amount of time such payments cover and do not allow payment of unemployment compensation until that time has expired. Accumulated vacation time, vacation pay, or a leave of absence also postpone or prevent the payment of benefits.

Ordinarily, state unemployment compensation statutes provide benefits for those who are unemployed because of their employer's inability to provide work for them. An employee who is discharged may receive benefits unless he was discharged for good cause. Good cause for dis-charge usually is related to recent misconduct on the job. Misconduct in private life or during off-duty hours may constitute good cause for firing an employee if it affects the person's work. Care-lessness, disregard for the employer's interest, intoxication, the use of illegal drugs, illegal work slowdowns, use of abusive language, absenteeism, and habitual lateness can be reasons for a discharge and denial of unemployment benefits. A person denied benefits may appeal this determination, first to a state administrative office and then to a court of law.

An unemployed worker is required to be available for work. This means that the person must actively seek a new job while collecting benefits. In cases where it appears that the person is not willing and able to work, he has no right to receive unemployment compensation. Workers who leave a job to find a better job or to attend school are not eligible for benefits. An individual who is too ill to work, who has no means of transportation, or who refuses to accept more than a small amount of work to avoid forfeiting retirement benefits is not regarded as being available for work. Employees who are on strike generally cannot collect unemployment compensation. However, individuals in such circumstances may qualify for other types of government aid.

An individual who is out of work is given no guarantee that he will find an attractive and convenient job. If jobs are available, even outside the person's local area, he is required to find one. An individual is not, however, disqualified from receiving unemployment compensation merely because he has recently moved, except in cases where no employment is available in the new locality. An unemployed worker cannot decline to accept a new job because he does not like the wages or hours. A person who refuses to accept a job is no longer entitled to receive unemployment compensation if the job is reasonable and suited to his skills.

In 2000, the labor department issued rules that allowed states to provide unemployment compensation benefits to parents after the birth or adoption of a child. An extension of the Family and Medical Leave Act of 1993, the new Birth and Adoption Unemployment Compensation (BAA-UC) was to be funded by individual state unemployment compensation funds. Several states took steps to initiate programs, but no state adopted legislation. Opponents of the program claimed that it was contrary to federal compensation policy, which is in place for individuals who are unemployed through no fault of their own. They also contended that BAA-UC would put an additional tax burden on employers, and that it would deflate a compensation system that was already in funding jeopardy. In 2003, the Labor Department moved to dismantle the program.

further readings

Drew, Erin P. 2001. "The Birth and Adoption Unemployment Compensation Experiment: Did the Department of Labor Go Too Far?" Dickinson Law Review 106 (fall).

Schiff, Wm. Michael. 2000. Unemployment Compensation Handbook. Indianapolis: Indiana Chamber of Commerce.

Unemployment Compensation and the Family and Medical Leave Act: Hearing Before the Subcommittee on Human Resources of the Committee on Ways and Means, House of Representatives, One Hundred Sixth Congress, second session, March 9, 2000. 2001. Washington, D.C.: U.S. Government Printing Office.


Employment Law; Labor Law; New Deal; Old-Age, Survivors, and Disability Insurance; Workers' Compensation.

Unemployment Insurance

views updated May 14 2018


The Social Security Act of 1935, commonly associated with the nation's old-age pension system, also created a national system of unemployment compensation—a guarantee of income for temporarily unemployed workers. At the time of the act's passage, this provision seemed more of a historic milestone than did the old-age insurance provision, which is now synonymous with the term Social Security.

To most Americans on the eve of the Depression, the idea of unemployment insurance was an unwelcome European import—a "dole" that undermined the work ethic and the fiscal stability of the nation. This view reflected the fact that policies to assist unemployed workers were a European invention. In the early decades of the twentieth century a number of countries in continental Europe began to augment union-sponsored out-of-work plans with tax funds. But when the Depression struck, it was England's pioneering program that was the most closely associated with the term unemployment insurance.

The British unemployment system, passed in 1911, created a large central fund financed initially by "contributions" from employees and employers, although the government also subsidized the program with general tax revenues. Thus the policy looked more like "insurance" than traditional relief, a fact that was constantly emphasized by its proponents. Between 1911 and 1930, ten other countries in Europe adopted compulsory unemployment insurance programs.

The British precedent generated much enthusiasm among American reformers. A key center of support for unemployment insurance was the University of Wisconsin in Madison, where economics professor John R. Commons developed a uniquely "American" version of unemployment insurance. Commons's "Wisconsin plan" focused more on preventing unemployment than on creating funds to assist the jobless. Commons proposed an unemployment tax on employers, with the rates adjusted for "experience" and the funds channeled into individual "reserves." Employers with healthy employment records would pay less than those who tended constantly to lay off and then rehire workers at various points in the business cycle. The goal was to encourage stable employment and avoid what were perceived as European-style doles from large central funds.

Commons's plan was, in part, a response to the strong opposition in the United States to European-style social insurance in the 1920s. The British system, which experienced a constant financing crisis throughout the 1920s, seemed to prove that government-mandated insurance proposals would quickly evolve into doles. Although numerous commissions were organized to study the problem, no state had established unemployment insurance prior to the 1930s.

The Great Depression turned the tide in favor of unemployment insurance. Insurance plans organized by private enterprises collapsed, and local private charity and public relief were inadequate substitutes for a national unemployment policy. The federal government was soon forced to take up the unemployment relief burden. By the time Franklin D. Roosevelt was inaugurated, Washington was financing the bulk of aid to the unemployed through local welfare agencies. There now seemed to exist a national "dole" more insidious than any European import.

Roosevelt voiced his support for state-level unemployment insurance in 1931, and the policy was endorsed by the Democratic platform for the 1932 presidential elections. In the early months of the New Deal several proposals for unemployment insurance surfaced, but none received sustained congressional attention. Then, in early 1934, Senator Robert F. Wagner and Representative David J. Lewis of Maryland introduced a bill that would profoundly shape the Social Security Act of 1935.

The Wagner-Lewis bill proposed a policy that became known as a tax-offset plan. A federal tax of 5 percent on employers' payrolls would be levied to finance benefits for the unemployed. If states passed their own unemployment insurance laws, employers would receive a credit against the federal tax. In short, the federal tax was a mechanism to encourage state-operated unemployment insurance systems. This formula was introduced, in part, out of fear that the Supreme Court would find a strictly federal program unconstitutional.

Roosevelt, however, disliked certain aspects of the Wagner-Lewis plan. He believed that employees, as well as employers, should pay into this "insurance" system. Furthermore, the New Deal was considering other related social reforms, such as an old-age pension plan and a public employment policy to replace relief. Thus, in June 1934 Roosevelt proposed a broad Committee on Economic Security to study the "great task of furthering the security of the citizen and his family though social insurance."

Although the Committee on Economic Security was designed, in part, to resolve conflicts over unemployment insurance, it temporarily intensified them. The Depression had increased support for reform but also generated sharp divisions among reformers themselves. While many supported the Wisconsin plan, which focused on individual employer reserves, others believed that this approach would provide inadequate benefits. They supported what became known as the "Ohio plan," which advocated state-wide "pooled funds." Still other members of the Committee on Economic Security advocated a national system operated by the federal government.

The debates over the unemployment provisions of the social security legislation dominated the committee's work in late 1934. In the end, these conflicts were resolved by adopting a version of the Wagner-Lewis tax-offset approach. The Committee on Economic Security proposed a federal tax (3 percent of payroll by 1938) to be reduced by up to 90 percent if a state system was established. The proposal mandated that one-third of the tax would finance a state "pooled" fund (Ohio plan), but also that federal credits would be given to state plans that created employer reserves based on experience (Wisconsin plan).

National unemployment insurance became federal law with the passage of the Social Security Act in 1935. In the final legislation, Congress stuck to the basic tax-offset formula, but modified the Committee on Economic Security proposal on significant points. For example, the requirement that one percent of payroll be earmarked for "pooled funds" was eliminated, a defeat for the proponents of the Ohio plan. Congress also weakened the ability of federal officials to influence procedures for the selection of personnel. Finally, the federal law excluded employers of agricultural workers from the tax.

Over the years, the system has been expanded to include workers not originally covered. The "American plan" of individual reserves, championed by the Wisconsin reformers, proved impractical. All states adopted the approach of creating pooled funds along with an "experience rating" of employer contributions, in which employers with good employment records were rewarded with lower payments into the system.

Numerous policy experts have criticized the state-level unemployment compensation system as inefficient, but such critiques have not generated significant political debate. Ironically, unemployment insurance, one of the most controversial policy issues in the years that preceded the Social Security Act, has generally avoided the public controversies that have marked other provisions of the 1935 law.



Altmeyer, Arthur J. The Formative Years of Social Security. 1966.

Berkowitz, Edward D. America's Welfare State: From Roosevelt to Reagan. 1991.

Haber, William, and Murray, Merrill G. Unemployment Insurance in the American Economy. 1966.

Lubove, Roy. The Struggle For Social Security, 1900–1935. 1968.

Nelson, Daniel. Unemployment Insurance: The American Experience, 1915–1935. 1969.

Jeff Singleton

Compensation, Unemployment

views updated Jun 27 2018

Compensation, Unemployment


Unemployment compensation (or benefit) consists of an insurance payment, generally financed by payroll contributions, that is paid to workers entering unemployment. This public insurance payment allows workers to smooth their consumption patterns when facing adverse employment outcomes in the presence of financial market imperfections and incompleteness that make it impossible or too costly for private, for-profit insurance firms to cover workers against such risks. The compensation is usually available for a limited amount of time, during which unemployed workers are supposed to search for a new job.

The first unemployment insurance system was introduced in 1789 in Basel, Switzerland, by a local trade union. More comprehensive schemes, managed by local authorities, were set up in France, Belgium, and Switzerland in the late nineteenth century. The first national program was established in the United Kingdom in 1911. Germany and the United States followed with, respectively, the Job Placement and Unemployment Insurance Act of 1927 and the Social Security Act of 1935 in response to the Great Depression. Nowadays unemployment compensation schemes are widespread under alternative enforcement rules and regulations in many Organization for Economic Cooperation and Development (OECD) countries.

One way of measuring the generosity of the unemployment compensation program adopted in a country is by calculating the amount of the average compensation as a ratio of the average wage. This indicator is known in the economic literature as replacement ratio. Another important characteristic of unemployment compensation schemes is the duration of the benefit, which can range from a few months to indefinitely. A further important element of unemployment compensation programs is the strictness of the enforcement rules governing the reception of the benefit. For example, sometimes unemployment compensation is conditional on the recipients actively searching for a new job or on accepting any job offered. These rules may be enforced with different degrees of strictness, depending on the formal and informal rules prevailing in each country. In the United States unemployment benefits are paid only to workers who lose their jobs as a result of dismissals; employees who voluntarily quit their jobs and new entrants to the labor market are not eligible. Federal law provides general guidance for administering unemployment compensation schemes, and each state has its own regulations and eligibility criteria.

Despite helping the unemployed in hard times, unemployment compensation schemes may also have perverse effects. Economic theory predicts that generous unemployment benefits tend to increase reservation wages. As a result, if the compensation is provided for an indefinite period, unemployment could increase as workers have less incentive to enter employment. In turn this could increase the average length of unemployment spells, triggering a rise in long-term unemployment. With this in mind, many countries have constructed unemployment compensation schemes that are limited in duration and contingent on active job search.

SEE ALSO Duration Models; Psychological Capital; Recession; Unemployment; Welfare; Welfare State


Bertola, Giuseppe. 1999. Microeconomic Perspectives on Aggregate Labor Market. In Handbook of Labor Economics, vol. 3c, eds. Orley Ashenfelter and David Card, 29853028. Amsterdam: North-Holland.

Cahuc, Pierre, and André Zylberberg. 2004. Labor Economics. Cambridge, MA: MIT Press.

Layard, P. Richard G., Steven J. Nickell, and Richard Jackman. 1994. The Unemployment Crisis. Oxford and New York: Oxford University Press.

Luca Nunziata