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BHI FaxSheet: Information and Updates on Current Issues

Creating Jobs by Reducing Unemployment Insurance Costs

June 1996

Massachusetts would create 15,000 new jobs by adopting a proposal to reduce the state’s unemployment insurance tax. The proposal, now before the Massachusetts legislature, has been offered by the Coalition for Unemployment Insurance Reform, a group of Massachusetts business organizations. The Beacon Hill Institute at Suffolk University (BHI) has estimated the job effects of the proposal by using STAMP, the institute’s State Tax Analysis Modeling Program.

One finding reached by the institute is that Massachusetts employment is significantly and negatively related to unemployment insurance rates. Reducing the tax would induce Massachusetts employers to create more jobs by reducing the cost of adding workers.

Unemployment Insurance: A Costly Proposition for Massachusetts Business

Massachusetts employers face the second highest unemployment insurance cost per employee in the nation as the result of an exceptionally generous unemployment insurance program. Many factors, including the following, contribute to this high cost:

readball The limit for receiving maximum benefits is 30 weeks, the most generous in the nation, and 15 percent higher than the 26 weeks, at or below which almost all other states limit benefits.

red The prior work requirement is 15 weeks of employment. Only ten other states have the same requirement, while 28 require at least 20 weeks of prior work.

red Workers with dependents receive extra benefits under a supplemental payment scheme that is by far the most generous in the country. Only 12 other states offer dependent benefits.


A Proposal to Cut the Cost of Providing Jobs

The proposed legislation attempts to align the Massachusetts program more closely with those offered by other states. It includes raising the prior work requirement to 20 weeks and reducing employer contributions in 1997, the first net reduction since 1986. Analysis by the Massachusetts Department of Employment and Training shows that the proposal would reduce the average cost per employee in Massachusetts from $476 to $419, a reduction of approximately 12 percent.

Massachusetts faces an increasingly competitive economic environment in which businesses have greater mobility than ever and are more sensitive than ever to interstate differences in the costs of production. The proposed legislation aims to make the state more competitive by reducing the cost of creating jobs.


How the BHI Model Works

The BHI Model is a dynamic, market-clearing model designed specifically to show how changes in tax law affect the behavior of employers and workers. The model assumes that prices eventually adjust in such a way as to push the labor market toward "equilibrium" and that the supply of capital to firms in the state is perfectly elastic.

In determining the equilibrium level of Massachusetts employment, the model estimates the behavioral responses of workers and employers to changes in various exogenous variables, including tax rates, that are determined outside the model. The exogenous variables that drive the BHI model are:

red the "labor endowment" (working-age population) of the state economy E;
red state after-tax unearned income Yu;
red state government transfer payments Gtr;
red the federal individual income tax rate tf;
red the state individual income tax rate ts;
red the U.S. unemployment rate u;
red the state unemployment insurance tax rate v unemployment insurance contributions divided by payroll;
red the components of the cost of capital to firms, the discount (interest) rate i, the capital replacement rate d, the present value of depreciation allowed for tax return purposes for $1 of capital c, and the total tax rate on corporations (including tax on dividends, capital gains, and income) t .

The results of the estimation of employment, with t-values in parentheses and * indicating statistical significance at the 5 percent level, are as follows:

LnL = 2.212lnE - 0.069lnGtr + 0.067lnYu - 0.006tf - 0.044ts - 0.012u - .039v + 0.109d + 0.007c + 0.011i - 0.003r.
    (12.26)*   (-1.73)   (3.25)*   (-2.78)*   (-4.72)*   (-5.5)*   (-2.54)*   (2.69)*   (2.09)*   (2.44)*   (-2.48)*


The model shows a negative coefficient on the state unemployment insurance tax rate, v, implying that as unemployment insurance costs are reduced, employment in the state increases. The estimated coefficient is significant at 5 percent, and indicates that a one-percentage point reduction in the unemployment insurance tax rate increases employment by 3.9 percent.


How Many More Jobs?

We apply this estimation to forecast the increase in employment that would result from the implementation of the proposal before the legislature. It is projected that the proposed reform would reduce the annual cost to employers from $476 to $419 per employee. This saving represents a reduction in the unemployment insurance tax rate of 11.97 percent. The current tax rate would therefore fall from 1.10331% to 0.9712% -- a decrease of 0.1321 percentage point. Using our estimated results, this would increase the employment level by 0.51% (= 3.9% * 0.1321). Nonagricultural employment in the state is 3,006,575 (based on data for the first four months of 1996 from the Massachusetts Department of Employment and Training). Based on this, we predict that the proposal will create 15,334 new jobs.


Kathleen M. Lang, PhD, BHI research associate, prepared this BHI FaxSheet. Persons having further questions should contact Ellen F. Foley, BHI director of communications at bhi@beaconhill.org, or by calling (617) 573-8750.


 

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