Search Penny Hill Press

Friday, March 11, 2011

The Effect of Unemployment Insurance on the Economy and the Labor Market

Thomas L. Hungerford
Specialist in Public Finance

In December 2010, Congress passed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (P.L. 111-312), which among others things temporarily extended the Emergency Unemployment Compensation (EUC08) program at an estimated cost of $56.5 billion—the eighth time EUC08 was extended. Before each vote, there were calls from some to end the program, arguing that the Unemployment Insurance (UI) program increases unemployment and does not stimulate the economy. It has been argued that UI subsidizes unemployment and creates a disincentive to look for a job, thus increasing the duration of unemployment. Some assert that this will increase the unemployment rate, reduce the production of goods and services, and reduce economic growth. Others emphasize the traditional view that UI and extending UI benefits during economic downturns serves as an economic stimulus, puts money into the economy, and helps create jobs. Since unemployment is likely to remain relatively high throughout 2011, further extensions of the EUC08 program could be considered by the 112th Congress. This report examines the effect of the Unemployment Insurance program on the economy and the labor market.

Total Unemployment Insurance benefit payments increase automatically during recessionary periods as the unemployment rate increases and unemployed workers apply for benefits. Total benefit payments decrease during economic expansions as unemployed workers return to work. UI payments provide an automatic counter-cyclical fiscal policy expansion that dampens fluctuations in economic activity, which is often enhanced by temporary legislation. Consequently, the UI system is said to be part of the automatic stabilization tools of the government that boost economic output during recessions.

But a higher level of Unemployment Insurance benefits appears to increase the duration of unemployment spells, thus increasing unemployment. One recent study, however, suggests that this may be mostly due to a liquidity effect (i.e., UI benefits allow unemployed workers, who would have to reduce consumption levels without benefits, to maintain consumption levels while unemployed), which reduces the pressure to find a new job quickly, rather than to moral hazard (i.e., disincentive effect) and concludes that the optimal level of UI benefits could be close to its current level. Furthermore, the UI system may reduce the duration of unemployment spells of individuals not eligible to receive UI benefits. Overall, the various studies indicate that the UI system has an indeterminate effect on the unemployment rate.

Date of Report: March 9, 2011
Number of Pages: 15
Order Number: R41676
Price: $29.95

Follow us on TWITTER at or #CRSreports

Document available via e-mail as a pdf file or in paper form.
To order, e-mail
Penny Hill Press  or call us at 301-253-0881. Provide a Visa, MasterCard, American Express, or Discover card number, expiration date, and name on the card. Indicate whether you want e-mail or postal delivery. Phone orders are preferred and receive priority processing.