Do Jobless Benefits Raise Unemployment?

Extending benefits, a key to the tax deal, may keep some at home, but it will also boost growth

For Democrats, the timing was awkward. On Dec. 7, the morning after President Barack Obama announced a tax-and-spending deal with congressional Republicans that will extend unemployment benefits for another 13 months, the Bureau of Labor Statistics announced that there were 3.4 million job openings as of the end of October.

In other words, millions of jobs are going unfilled at the same time that millions of out-of-work Americans are getting checks for being unemployed. That's red meat for free-market conservatives who dislike government meddling in the private sector. Under the deal's terms, wrote Erick Erickson, editor of the influential RedState blog, "we will also continue subsidizing unemployment—yes you read that right. At some point it becomes welfare, not unemployment compensation."

Obama is making no apologies for a provision he says will be a lifeline to the families of the unemployed as well as a stimulus to the economy. "There are people right now who, when the unemployment insurance runs out, will not be able to pay the bills," he said at a Dec. 7 news conference.

Liberal Democrats were angry that the budget deal preserves the Bush tax cuts for the highest-income families and pegs the estate tax at a lower-than-scheduled 35 percent, with a full exemption for estates worth less than $5 million. To fire up growth, the agreement also allows businesses to write off 100 percent of their capital spending as a business expense next year. Capital gains and dividends taxes stay at 15 percent.

Help for Lower Incomes

Yet the deal includes plenty of help for lower-income Americans, including not only the unemployment benefit extension but also a temporary 2-percentage-point cut in the Social Security payroll tax and continuations of the earned-income and child tax credits.

Brokering a deal required giving both sides the goodies they wanted, so the deal contains more stimulus than most economists had expected. High Frequency Economics, an analyst group, raised its 2011 U.S. growth forecast to 3 percent from 2.5 percent. Goldman Sachs (GS) economists estimated the gross domestic product boost at a half to a full percentage point over previous expectations.

The one part of the deal that could irk some GOP stalwarts is the extension of jobless benefits. Do the extra checks make unemployment higher than it would otherwise be by paying people to sit at home? Or do the checks sustain growth by supporting the spending power of households with out-of-work breadwinners?

In truth, unemployment benefit extensions do both—they raise the jobless rate a bit, and they make the economy grow faster. What's clear is that extending jobless benefits makes more sense when the unemployment rate is exceptionally high, as it is now, at 9.8 percent in November. Although there may be a lot of jobs open at any given moment, most are quickly filled because there are so many job seekers. That makes the 3.4 million jobs open on the last day of October seem less impressive. And because aid to the jobless is almost immediately spent (as opposed to tax refunds for the wealthy), it is the most effective means of stimulating demand, the nonpartisan Congressional Budget Office said in a Sept. 28 report.

Deal Preserves Extensions

The deal struck by Obama on Dec. 6 came a week after the expiration of the latest extension of unemployment benefits. If Congress rejects it, about 2 million people will begin to lose extended unemployment benefits this month, and about 7 million will lose them by November 2011, according to the President's Council of Economic Advisers. Although state unemployment benefits ordinarily last just 26 weeks, Congress has passed a series of federal extensions that give people up to 99 weeks—nearly two years' worth. The deal would keep those extensions in place through the end of 2011. Ninety-nine weeks, however, would still be the maximum.

Economists have long known that unemployment benefits induce some people to pass up available jobs. But how many people? In April, Rob Valletta and Katherine Kuang, economists at the Federal Reserve Bank of San Francisco, used a simple but clever technique to answer the question. They looked at whether the duration of unemployment was longer for people who lost their jobs (and thus were probably collecting unemployment insurance) than for people who voluntarily left their jobs or were new entrants to the labor force (and were less likely to be receiving benefits). They found only a small difference, implying by their calculation that the extension of benefits added about 0.4 percentage point to the jobless rate in late 2009. At the request of Bloomberg Businessweek they did an update through November 2010 that yielded a new estimate of 0.8 percentage point. "I can't make a strong case for which is correct," Valletta wrote in an e-mail.

Anthony Roebuck, 44, a union sheet metal worker from Brighton, Colo., who was laid off from a construction company in April, scoffs at the notion that he would pass up a job because he'd rather collect unemployment benefits. The AFL-CIO put a reporter in touch with him by phone. Finding work is partly a matter of pride and partly a matter of necessity, Roebuck says. Jobless benefits aren't enough to live on: "When you're in the working part of America, you typically live to what your paycheck is, aside from putting a little money aside. When that paycheck is taken away, you're living beyond your means."

The bottom line: Although the Obama-GOP tax deal extends unemployment benefits, it probably will not dissuade many jobless from seeking work.

With Albert R. Hunt in Washington D.C. Coy is Bloomberg Businessweek's Economic editor.