Expanded Unemployment Benefits May Have Discouraged a Faster Recovery

By Michael D. Farren and Christopher M. Kaiser

In March 2020, in an effort to help workers who had lost their jobs because of the COVID-19 pandemic, the federal government offered to expand the generosity and coverage of states’ unemployment insurance (UI) programs. Since then, vaccines and other mitigating factors have reduced the pandemic’s economic disruptions. In response, 26 governors unexpectedly announced that they would suspend participation in the federal expansion of UI benefits by late June or early July 2021—more than two months before the federally scheduled end date of Sept. 6.

In August, when the July jobs report from the Bureau of Labor Statistics (BLS) was released, some journalists and economists were quick to point out that “states that ended enhanced federal unemployment benefits early have so far seen about the same job growth as states that continued offering the pandemic-related extra aid.” In other words, they claimed that curtailing UI did not increase job growth, contrary to economic theory and prior empirical research.

But their assessment was only a surface-level correlation between UI benefits and job growth. Importantly, this is not the same as evidence that proves whether ending the UI expansion early had an effect on the labor market. Our preliminary research suggests that, when factors affecting the labor market are properly incorporated into the analysis, UI benefits tended to inhibit workers’ return to employment, a conclusion that is consistent with previous research.

Pandemic Changes to Unemployment Insurance

The public debate over the merits of a federal expansion to state UI programs began even before the Coronavirus Aid, Relief, and Economic Security (CARES) Act was passed in March 2020. Whether expanded and extended UI benefits would discourage some recipients from returning to work has been a hotly debated issue. It flared up each time the temporary programs expired and Congress had to decide whether and how they should be renewed. Following the widespread availability of effective vaccines against COVID-19 beginning in April 2021, the debate shifted to how and when to appropriately end expanded UI benefits. With 26 states deciding to end these benefits early, a unique opportunity arose to estimate the effect of UI changes on workers’ return to employment.

Among other things, the CARES Act created three programs: Federal Pandemic Unemployment Compensation (FPUC), Pandemic Unemployment Assistance (PUA) and Pandemic Emergency Unemployment Compensation (PEUC). FPUC increased the weekly benefits that workers received (initially by $600 per week, then later by $300 per week). PUA expanded UI to self-employed workers, who had not previously paid into the UI program and therefore were not eligible for benefits. PEUC extended program eligibility for those workers who had exhausted their state UI benefits.

Later legislation renewed but reduced FPUC’s expanded weekly benefits after the program lapsed and further extended PEUC’s unemployment benefits from 39 weeks to as many as 79 weeks. Additionally, the programs’ effect on participants’ return to work was likely exacerbated by state-level changes to eligibility rules that no longer required program participants to actively search for reemployment.

From its conception, UI has been designed to mitigate its theoretically anticipated effect of discouraging participants’ return to work. In short, if you’re paid to be unemployed, then you might stay unemployed longer than you otherwise would. Periods of unemployment tend to erode human capital and job market connections, and as the duration of unemployment increases, workers’ future income tends to decrease. So program parameters are typically constructed to motivate participants to resume employment as soon as possible. These parameters generally include the following:

• Low value of benefits: generally replacing 40% to 50% of workers’ preemployment income, up to some cap.

• Limited benefit duration: generally about 26 weeks, although there is some variation among states.

• Restricted program eligibility: UI is generally available only to previously employed workers with a recent history of consistent employment. Furthermore, UI beneficiaries must actively search for new employment while enrolled.

• Mandatory program exit: Participants must accept a job offer that is appropriate for their skill set.

This approach received substantial criticism during the COVID-19 pandemic. Many political commentators insisted that fear of infection and parents’ increased child care responsibilities were the primary determinants of workers not returning to work, rather than the potential disincentive caused by UI benefits. But those reasons for avoiding employment likely had the largest impact at the beginning of the pandemic, when it made sense to err on the side of caution before reliable information was available and effective safety protocols were instituted.

As time has gone on, pandemic-based arguments against returning to work have weakened:

• The widespread availability of effective vaccines for adults beginning in April 2021 (and teenagers in May) should have reduced many workers’ concerns regarding the consequences of workplace-caused infection.

• Recent research by former Council of Economic Advisers Chair Jason Furman and economists Melissa Kearney and Wilson Powell III finds that parents did not reduce their amount of work during the pandemic, suggesting that lack of child care has not affected most parents’ employment status.

• Vaccine availability for adults and teenagers enabled more child care facilities to reopen during the summer, although the increased transmissibility of the delta variant, especially among children, complicated the reopening of camps and other typical summer programs.

As the fear of the virus diminished and weary parents had more access to child care, federally expanded UI likely played a proportionally larger role in explaining why those who were jobless continued to remain so.

Concerns over the employment-discouraging effect of federal UI extension programs climbed even higher when the May 2021 release of the April jobs report showed unexpectedly weak employment growth. Just before this news, Montana Gov. Greg Gianforte announced that the state would reinstitute work search requirements for UI eligibility, provide a return-to-work bonus, and suspend its participation in all three federally expanded UI programs. After the April jobs report, many other states opted to follow Montana’s lead.

The federal expansions to UI might have reduced the likelihood that people returned to work because unconditional monetary grants to unemployed workers tend to raise their reservation wage—the compensation level necessary for a worker to take a job. Furthermore, the expanded weekly benefits provided by FPUC (as well as the American Rescue Plan’s exemption of $10,200 of UI benefits from federal income tax) meant that many low-wage workers saw no decrease in their weekly income, and some even saw an increase. This program redesign was arguably appropriate when COVID-19 was rapidly spreading and medical systems were in danger of collapse, but it seemed less appropriate following the widespread availability of effective vaccines.

What Do the Data Really Show?

The effect of UI on labor markets has been studied extensively, and previous research has consistently found that greater UI benefits cause longer periods of unemployment. The exact size of this effect vs. the social benefits of UI is often debated, but there is broad consensus that increased UI benefits or extensions to eligibility do slow some workers’ return to employment.

Our own ongoing research examines the labor market effects experienced by states that terminated federal UI programs early, using the same data that the BLS uses for the monthly jobs report. We analyze differences in labor markets between those states that did and did not cut federal benefits early, across the period before states announced their withdrawal (March to May 2021) and the period following full termination of states’ participation in federal UI programs (May to July 2021). To account for other differences among states that might have affected their labor market outcomes, we control for states’ COVID-19 case and death counts, the proportion of each state’s population most susceptible to retirement and most likely to require child care, and the percentage of each state’s jobs lost during the pandemic.

While other research appears to have separated the states into the 26 that terminated participation in some or all federal UI programs and the 25 (including the District of Columbia) that did not, there is substantial variation within each of these groups. During our analysis period, 11 states faced legal challenges to their early exit from federally expanded UI programs. This distinction is relevant because workers in those 11 states might have thought there was a chance they could continue receiving expanded UI benefits—which in some cases were larger than their pre-pandemic income—and therefore might have spent less time job hunting than workers in the 15 states who were certain about the end of the program.

Furthermore, four states ended only the additional $300 per week available through the FPUC, whereas 22 ended participation in all three federal expansions to UI. In addition, a mix of states offered “return-to-work bonus” programs, which might also have affected jobless workers’ likelihood of returning to the labor market.

To clearly identify the effect of terminating participation in federal UI programs, our analysis focuses on the 11 states that did so without either facing legal challenges or instituting return-to-work bonuses, in comparison to the 19 states that continued participation without any other policy changes.

Expanded UI Discouraged Some Workers’ Return to Employment

Our preliminary results agree with the findings of previous research: Higher UI benefits tend to discourage employment, whereas the end of UI eligibility appears to motivate more workers to become employed. However, the results are not one-sided—labor market outcomes clearly vary, even between states that pursued the same policy.

One interesting insight is that worker-focused data show different results than business-focused data. The worker-focused data suggest that states that terminated federal UI program participation experienced twice as fast employment growth as did states that continued the programs. By contrast, the business-focused data suggest that the states that terminated their participation in federal UI programs experienced employment losses, whereas states that continued the programs experienced employment gains.

Given that the worker-focused data directly addresses workers’ labor market status, those results seem more relevant, but others might argue that the better data collection of the business-focused data tells the truer story. Regardless, the important takeaway is that the difference in the datasets might be driving the contradictory narratives being debated in the media.

Implications for the UI Debate

Some pundits rushed to the defense of federally expanded UI programs when the July jobs report was released, arguing there was no evidence that the programs discouraged employment. But this perspective cannot be reconciled with economic theory or with decades of labor market research. Even research that has been framed as proof that the federal expansion to UI had no employment-discouraging effect itself acknowledges that workers were 20% more likely to accept jobs in states that had opted out of the UI expansion.

While this effect on the labor market may be small in pre-pandemic terms, it is a far cry from the narrative that unemployment insurance has no impact on employment. Furthermore, no research to date has examined what the total work disincentive may be from the amalgamation of other pandemic-related government policies, such as increased rental assistance, food stamps, retirement assistance and healthcare benefits, all of which may also discourage some workers’ return to work. In short, the aggregate effect might be far larger than many people suspect.

It is entirely possible that jobless workers fear workplace-related COVID-19 infection or face child care difficulties, and these are legitimate reasons for delaying their return to the labor force and availing themselves of UI benefits. But the widespread availability of effective vaccines and the resurgence in travel and entertainment spending indicates that these reasons probably carried less weight as the pandemic wore on.

Our own analysis is a work in progress and is subject to refinement and revision as more data become available. More work remains to be done because the pandemic-caused recession clearly showed that America’s existing UI system is woefully inadequate to the task of helping workers weather economic downturns.

Unemployment insurance is important, and not just for the workers receiving benefits. It improves economic efficiency by enabling workers to find higher-quality employment matches—characterized by high productivity, satisfactory compensation and a healthy working environment—as opposed to feeling pressured to take any job at all to replace their lost income. But you can have too much of a good thing. Reaching a better understanding of how workers respond to UI benefits is essential to reform the UI system so that it is both targeted and effective.