If the public is ever to feel comfortable with Social Security reform, it needs to see a trial run.
Mr. Hood is president of the John Locke Foundation, a state-policy think tank in Raleigh, North Carolina, and the publisher of a new monograph entitled Savings & Loans: Reforming Unemployment Insurance through Competition and Compound Interest.
It has long been a free-market dream: changing Social Security from a redistributionist, pay-as-you-go social program to a personalized system of private retirement accounts. Once confined to Cato Institute seminars and Philadelphia Society meetings, the idea now has lawmakers of all ideological stripes buzzing. And yet, a big political obstacle remains. Privatizing Social Security would be reform on a grand scale, involving many billions of dollars — and the retirement prospects of many elderly and near-elderly voters.
What reformers need is a trial run, a demonstration that average folks can manage their money just as well as government bureaucrats can (or, indeed, better). Supporters point to Chile, Australia, and Great Britain as proof that it can be done.
But promising as these examples are, most Americans won’t be convinced until they have seen an example closer to home. Policymakers can create one: by letting states privatize Unemployment Insurance.
The Unemployment Insurance program was created by the same legislation as its bigger cousin, the Social Security Act of 1935. A joint federal – state program, UI provides two services: the promise of UI benefits in the event of a layoff, and the operation of Employment Service job offices throughout the country.
UI is one of our largest social programs. Like Social Security, it is financed by payroll taxes — to the tune of $23 billion in 1997. Also like Social Security, it runs an annual surplus, and its accumulated “trust fund” ($35 billion as of last year) must by law be invested only in federal Treasury securities and thus serves to mask the true size of the federal budget deficit.
There is another similarity to Social Security: Unemployment Insurance is an outmoded program that offers a bad deal to workers and is a drag on the economy.
In the first place, workers are eligible for UI benefits only if they have lost their job involuntarily and through no fault of their own. If you choose to leave one job in search of a better one, resign to follow your spouse to a new city, or are fired for what your manager calls “cause” (even if this is untrue), you cannot make a claim.
Furthermore, UI benefits are small and strung out over half a year. If what you need is money up front for retraining or to start your own business, you’ll have to get it elsewhere. The silliest part of the system is its requirement that beneficiaries must show evidence of “looking for work” every week in order to keep getting checks. This rule often creates an elaborate minuet of fraud — as in George Costanza’s antics on Seinfeld — with or without the complicity of UI bureaucrats. Efforts to enforce these and other convoluted UI rules jack up administrative costs significantly, further reducing the value of the program to the people whose taxes pay for it.
The bottom line is that millions of Americans are forced to pay into a UI system that offers them little or nothing in return. In only three states do more than half of unemployed workers ever see a dime of UI benefits.
Even the vaunted job-search component is far less than meets the eye. A national survey reported that only 4 per cent of UI beneficiaries found their new jobs through the government system.
The vast majority of people who are out of work, in other words, cope with unemployment in ways that don’t involve the UI system. We draw down our private savings to pay bills or go back to school. We use want ads, word of mouth, and private firms to find new jobs. Personnel agencies have been a growth industry for years, while many Americans now sock away several months’ worth of income in money-market funds and other safe but interest-bearing forms of investment. Anyone who wants some measure of security has to do these things, even though we are forced to pay into the UI system. That system essentially subsidizes a few industries with a high risk of layoff and pushes unemployment rates higher by inducing beneficiaries to stay out of the job market in order to collect as many benefit checks as possible.
THE way out of this morass is, not surprisingly, similar to what has been proposed for Social Security. The Unemployment Insurance system should be personalized and privatized. The first step is already underway. A coalition of 23 states and the private Unemployment and Workers’ Compensation Association is set to support a bill in Congress next year from Rep. Clay Shaw (R., Fla.) to devolve the UI system entirely to the states. Currently, states administer the program and collect part of the tax revenue, while Washington enforces strict rules and collects the rest of the taxes. The federal portion is spent on administration and on subsidies to states with troubled UI trust funds. Rep. Shaw’s bill is intended to eliminate waste and give states more authority to make their own decisions. Even the Clinton Administration admits that the current system is broken; it is reportedly preparing its own, less ambitious devolution plan.
The next step is to allow states to experiment with privatization. We already have a precedent here, too: workers’ compensation. While virtually all states require employers to purchase workers’ comp insurance for their employees, few require that government provide it. There is a competitive market of private insurers that sell workers’ comp policies. There is no reason to expect UI to be any different.
In North Carolina, the think tank I head, the John Locke Foundation, has already proposed a private alternative called Unemployment Savings Accounts (USAs). Employers would direct payroll taxes to their employees’ USAs rather than to state or federal coffers. A small portion of the payroll tax would go to a state trust fund that would loan money to new workers to set up their own USAs. Workers could select from a variety of USA plan administrators, including banks, insurers, and personnel firms. These administrators would not only manage the accounts but also, if workers wished, provide job-placement or job-training services. Unspent USA funds could be withdrawn after retirement or passed on to heirs.
Unlike government managers, private USA administrators would have incentives to provide the benefits workers actually need (such as lump-sum distributions up front for retraining) and to get workers re-employed as quickly as possible. Why? Because the firms would seek to maximize deposits so that they could make interest on them. Having workers pay into the system is far more lucrative for private administrators than having workers make withdrawals. The opposite is true for government managers, whose jobs and empires depend on serving as many UI claimants as possible for as long as possible.
Whether or not states chose to use USAs, devolution would serve as a useful trial run for Social Security privatization. The amount of money involved is far smaller, and so is the downside risk. As is now happening with electricity restructuring, some states would rush ahead, while others would move cautiously, looking to the former for examples of what to do — or what not to do. Of course, devolving and privatizing UI would also benefit workers. And it would boost the economy by reducing the length of time workers spent unemployed and making more private savings available for investment. Not bad for an unintended consequence.
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