The Structure of UI Taxes Affects Firms’ Layoff Decisions

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Unemployment insurance (UI) is an important factor in the US labor market. In 2019, more than 5 million Americans received UI benefits. Employer UI taxes are experience rated, which means that when workers claim unemployment benefits, the prospective UI tax rates of the firms that laid them off increase. In Experience Rating as an Automatic Stabilizer (NBER Working Paper 30651), Mark DugganAudrey Guo, and Andrew Johnston find that this tax penalty on firms reduces their propensity to lay off workers during downturns, and that it may have reduced the number of layoffs during the 2007–09 Great Recession by nearly 1 million.

The UI program typically provides laid-off claimants with weekly payments that replace approximately half of their earnings for up to six months. These provisions — both benefit generosity and duration — vary across states and can vary through time. Firms pay taxes designed to cover the cost of their workers’ benefits. In most states, the tax schedule is based on either a Benefit Ratio system or a Reserve Ratio system. An employer’s Benefit Ratio is defined as the total UI benefits claimed by the firm’s employees over the last three years divided by the total taxable payroll over the same period. An employer’s Reserve Ratio is defined as the sum of all UI contributions minus all previous UI claims, divided by the sum of the total taxable payroll in the last three years. The tax rate the employer must pay increases linearly with the Benefit Ratio or stepwise with the Reserve Ratio. Rates of increase, and the maximum taxable wage base, also vary by state and year.

The US system of increasing firms’ unemployment insurance taxes when they lay off workers makes many firms less likely to downsize after a negative economic shock.

The researchers obtain empirical tax schedules for 2001–19 from the US Department of Labor’s Form ETA 204 Experience Rating Reports, which are available for 46 US states and 86 percent of state years. They combine this with employment data at the state-year-industry level from the Quarterly Census of Employment and Wages.

The study defines experience rating as the firm’s marginal tax cost in the next year of laying off 10 percent of its workers in this year. This is a lower bound on the true cost, as a change in either the Benefit or the Reserve Ratio would affect the next three years or more of claims. To calculate the expected change in the Benefit or Reserve Ratio associated with a substantial layoff, the researchers assume benefit-eligible weekly earnings of $870 — the nominal average in their sample — a constant 32 percent take-up rate, and a duration of 16 weeks of claims both of which equal the US average during the sample period.

The researchers estimate the effect of the marginal tax cost of layoffs on the extent to which employers within a state downsize their workforces in response to negative industry shocks. They define these shocks as the year-over-year percentage change of national industry employment, excluding the employment in the firm’s own state and industry. They find that on average a national industry employment decline of 1 percent is associated with a 0.96 percent decline at the state-industry level. Against this backdrop, the average marginal tax cost of $89 per worker lowers responsiveness to national shocks by 0.09 percentage points, or about 11 percent. Additionally, experience rating reduces downsizing during contractions, but does not reduce growth during expansions, suggesting that it increases employment over the business cycle.

Industries at high risk of layoffs — defined as those whose tax rates are within the top quartile of industry rates — downsize when needed regardless of the marginal tax cost, while for lower risk industries, experience rating lowers responsiveness to shocks by 0.15 percentage points.

— Whitney Zhang