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Unemployment Benefits: No Free Lunch

Posted By James Sherk On November 30, 2012 @ 3:00 pm In Featured | Comments Disabled

Would spending more money on unemployment benefits create jobs? The Congressional Budget Office (CBO) thinks so.

According to a new CBO report, extending the current 73 weeks of unemployment insurance (UI) benefits would lead employers to create 300,000 new jobs [1].

This seems highly implausible. Economists widely agree [2] that UI causes workers to spend more time unemployed.

So how did the CBO conclude that UI spending creates jobs? Their assumptions virtually dictated the conclusion.

The CBO made three key assumptions:

  1. Government spending has a large “multiplier” effect in the economy and creates jobs;
  2. Unemployed workers spend every additional dollar of UI benefits they receive; and,
  3. Extended benefits have little offsetting effect on the unemployment rate.

These assumptions logically imply that additional spending on UI benefits creates jobs. That does not make these assumptions true. Academic research casts serious doubt on all three.

As the CBO acknowledges, the size of the “multiplier effect” is highly controversial. Government spending does not create wealth out of thin air; the government taxes or borrows those resources from elsewhere in the economy. Some studies find that government spending actually contracts the private sector [3]. It often does not stimulate growth—as the $500 billion spent on unemployment benefits during the recession demonstrates.

Neither do UI recipients spend every additional dollar of benefits they receive. Each dollar of UI spending increases consumption by about 55 cents [4]. Why not more? Because UI benefits often provide alternative financing for consumption that would otherwise take place without the benefits. UI recipients also (unsurprisingly) draw down their savings at a slower rate than those without benefits.

In addition, the spouses of workers without UI benefits work more hours than those getting the benefits. Each dollar of benefits a married man collects reduces his wife’s earnings between 36 and 73 cents [5].

Research also shows [6] that extended benefits have raised the unemployment rate during the Great Recession. University of Chicago economist Casey Mulligan finds that this has significantly held back [7] the labor market. Even Mark Zandi—one of the strongest supporters of the stimulus (and UI spending)—agrees on this point [8].

Had the CBO made different assumptions based on these studies, it would have come to a different conclusion.

The Heritage Foundation did this analysis at the start of the recession. We used a smaller multiplier and assumed only half of UI benefits finance new consumption and that benefits delay some workers’ return to work. With these assumptions, macroeconomic models show that extended benefits somewhat depress the economy [9].

This does not mean that Congress should return unemployment benefits to six months. UI benefits provide important assistance to those struggling to find jobs. Rather, Congress should make policy tradeoffs between the humanitarian benefits of UI spending and the economic costs they entail. But they should not be under the illusion that UI benefits are an economic free lunch.

Article printed from The Foundry: Conservative Policy News from The Heritage Foundation: http://blog.heritage.org

URL to article: http://blog.heritage.org/2012/11/30/unemployment-benefits-no-free-lunch/

URLs in this post:

[1] 300,000 new jobs: http://www.cbo.gov/publication/43734

[2] widely agree: http://www.heritage.org/research/testimony/2012/02/testimony-on-attempting-to-bolster-the-economy#_ednref1

[3] contracts the private sector: http://www.nber.org/chapters/c12632.pdf

[4] by about 55 cents: http://www.heritage.org/research/reports/2011/09/extended-ui-payments-do-not-benefit-the-economy#_edn11

[5] between 36 and 73 cents: http://www.nber.org/papers/w5608

[6] also shows: http://www.heritage.org/research/testimony/2012/02/testimony-on-attempting-to-bolster-the-economy#_ednref5

[7] significantly held back: http://www.amazon.com/The-Redistribution-Recession-Distortions-Contracted/dp/0199942218

[8] agrees on this point: http://www.jec.senate.gov/public/index.cfm?a=Files.Serve&File_id=df8f2728-94fa-4339-992a-a9b8d2505fc2

[9] somewhat depress the economy: http://www.heritage.org/research/reports/2008/11/extended-unemployment-insurance-no-economic-stimulus

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