Past Session:

Proceedings of the Standing Senate Committee on
Social Affairs, Science and Technology

Issue 8 - Appendix 2

Appendix 5900 S2-C-12, 8 "2"

IN SUPPORT OF THE UNEMPLOYMENT INSURANCE REFORM BILL C-12

(June 6, 1996)

Alice Nakamura
Winspear Professor of Business
Faculty of Business, University of Alberta
Edmonton, Alberta, Canada T6G 2R6
Phone: (403) 439-1960 in Edmonton or (604) 264-1549 in Vancouver
FAX: (403) 492-9924
Secretary: (403) 492-2457

EXECUTIVE SUMMARY

Bill C-12 introduces three key structural reforms which could make it possible for the new EI program to become a user funded insurance program that is fair to all participants, and that also serves this nation well as an automatic stabilizer:

(1) The first is to the proposed switch from Using weeks of work at UI covered jobs to using hours of covered work as the main unit of account for the program.

(2) The second is the new insensible rule, whereby the replacement rate for insured earnings would fall with increased use of the program over the previous five years.

(3) The third is the augmentation of the clawback provisions. These would result in repayment of greater amounts of the benefits collected by those with relatively high incomes, with the maximum repayment rising with increased use of the program over the previous five years.

My main purpose in this Brief is to explain why I support each of these reform measures.

In this Brief I lay out the main reasons why I am a strong supporter of the Unemployment Insurance (UI) reform Bill C-12: a bill that will make far reaching structural changes in our UI program and will also rename the program Employment Insurance (EI). To understand why this bill is important, it is necessary to understand certain basics about our old UI program. I begin by outlining these. The next section gives two alternative sets of principles that can be used for evaluating our old program and the Bill C-12 reforms: principles for a fair user funded insurance program, and principles of fairness for a public income transfer program. The third section considers three of the Bill C-12 structural reforms, while the fourth section discusses the advantages of a two stage process for phasing in major structural changes. The fifth section concludes.

THE PRESENT UI PROGRAM

The old UI program is a federal level program that provides partial income replacement for covered workers who have lost their jobs. To qualify for benefits under the old UI program it take 12 to 20 weeks of covered employment, depending on regional unemployment conditions. The mininum qualifying period of 12 weeks applies to workers in regions where the unemployment rate is 13 percent or more. The maximum qualifying period of 20 weeks applies to workers in regions where the unemployment rate is 6 percent or less. Types of employment that are excluded from coverage under the old UI program include jobs for under 15 hours per week, or that pay less than $163 per week; hours of work over the old UI cap on covered earnings of $815 per week; and self employment.

For those who become unemployed, who apply for benefits, and who have accumulated sufficient weeks of covered employment. the UI program provides income replacement at the rate of 55 per cent of insured weekly earnings (60 per cent for low income earners with dependent children) for a maxinunn of 10 to 50 week depending on the number of weeks worked in the previous year and regional unemployment conditions. In addition to these benefits, the old UI program also pays for education or training and other employment services for some of those collecting income replacement benefits, and, in some cases, income replacement benefits may be continued beyond the maximums that would otherwise apply to allow completion of education or training programs. Those who exhaust their weeks of unemployment benefits without finding work may be eligible for income support and other assistance from the provincial welfare programs: programs which are family means tested and are funded out of general federal and provincial tax revenues.

The old UI program, like the new EI one, is funded entirely by employer and employee payroll taxes on gross employee wage and salary earnings from covered employment. In 1995, the UI employee tax on covered earnings was $3.00 per $100 of earnings up to a weekly cap on insurable earnings of $815 per week and an annual maximum contribution per worker of $1,271. The UI employer tax was 1.4 taxes the employee tax, with maximum annual contributions of $1.780 for each employee. The tax rate for the old UI program was adjusted periodically so as to ensure that the program is self financing. The statutory UI tax rate was set on the basis of the financial state of the UI fund over the previous three years so that the insured earnings base for the UI program would cover the expected benefit and administration costs. A long period was used for determining the statutory tax rate to try to insure that it would not have to be raised substantially during a recession -- an objective that was not always realized.

The statutory rate could be overridden legislative amendment for specific purposes. At present, the actual UI tax rate is being kept higher so as to build up a UI (soon to be EI) fund surplus that could be drawn on in the next recession. Nevertheless, the employee and employer premiums will be reduced modestly under Bill C-12.

It should be noted that the Canadian UI program was not always paid for entirely win payroll tax revenues. That is, UI was not always entirely user funded. Prior to 1990, the federal government helped support the program out of general federal tax revenues. In the 1971 UI Act, the federal contribution to the UI fund was justified as helping to cover costs of unemployment above and beyond frictional unemployment (specified in the Act to be unemployment above four percent) and also the fishing benefits and the regionally extended UI benefits introduced in the 1971 Act. In the 1971 Act, it was not intended that regionally extended benefits would be user funded. The program was a more potent automatic stabilizer then, because of the added federal contribution in economic downturns, though it still plays an important role in that regard.

Also, prior to the 1971 revisions to the UI Act, there was a closer relationship between tax payments into the program fund by participants and the benefits they could draw when unemployed. It is important to note that prior to the 1971 revisions, those with UI covered jobs that were seasonal could not collect UI in the off seasons for their jobs. Fisheries workers were entirely excluded. Also, it is only since the 1971 and then subsequent 1978 revisions that those in higher unemployment regions could qualify for benefits with fewer weeks of covered employment and could receive benefits for longer than those in lower unemployment regions. The introduction of these changes made it so that those at higher risk for the insured hazard -- unemployment -- could qualify for greater coverage at a lower -- not a higher -- cost. This is the opposite of the usual relationship between required premium payments and systematic risk in private insurance programs

TVVO SETS OF PRINCIPLES

The "I" in UI (and in the new EI) stands for insurance. Insurance programs involve a pooling of risk among participants. All pay into a fund from which those who suffer the insured peril are then compensated. This compensation often exceeds the individual totals of the tax contributions to the insurance fund of the beneficiaries.

For a user funded insurance program to be intrinsically fair to all of the individual participants, the following two properties should be satisfied:

(i) The first is that the insured peril must be an undesired and unforeseen event.

(ii) The second is that there is experience rating of either the premiums or the benefits. That is, either higher premiums must be assessed, or the level of insurance coverage must be reduced, for those who are at higher risk of the insured peril so that the premiums cover the expected benefits for each participant.

When workers take jobs known to provide only part year work, and do not line up other work in the off periods, unemployment is not an unforeseen event -- whether or not it is undesired. In this situation, the risk of unemployment in the off periods is 100 per cent. If the premiums charged for known risks do not fully cover all benefits to be paid out for those risks (plus the administrative overhead), there will be a certain income transfer from other participants in the program to those destined to suffer the known risks. Since 1971, this sort of income transfer has become an increasingly important feature of our UI program, with increasing numbers of regular part year workers collecting UI year after year in the off periods from their jobs.

As noted above, under the old UI program those in higher unemployment regions can qualify for benefits sooner and can receive benefits for longer than those in lower unemployment regions. Yet they and their employers are assessed the same premium rates per $100 dollars of covered weekly earnings. Of course, those in higher unemployment regions tend to have fewer weeks of covered employment, so their annual total UI premium payments tend to be lower on average compared with the average for those in lower unemployment regions. Thus, under our old UI program, those at higher risk of the insured peril and who are expected to receive greater amounts of benefits, pay less for this coverage than those at lower risk and who have lower expected benefit claims. The old UI program does not satisfy either of the two principles of a fair user funded insurance program.

Of course, many of those with intermittent employment truly cannot find other work. Canadians have demonstrated, time and again, that they are willing to make personal sacrifices to provide financial assistance to others who are in need. Most economically self sufficient Canadians are willing to be taxed to provide income support payment for those who are without other means of support. However, there are three basic -- if not always explicit -- individual level conditions on this generosity:

(i) The first is that those needing help are willing to shoulder the same burdens that those providing the help must bear.

(ii) The second condition is that the transfer payment recipients do not have a higher standard of living than those being taxed to provide the help.

(iii) The third condition is the Robin Hood principle that charitable public programs should be paid for with funds from progressive taxation (that is, those who have more should contribute at a higher rate), or at any rate not from regressive taxation.

Our present Ul program violates all three of these conditions of fairness for a public income transfer program on an individual level. The easiest way to see this is through a hypothetical example.

Consider two workers, one win a regular 10 month job and the other who works year round. Suppose that the first worker is employed 40 hours per week, 4 weeks per month, for $20 per hour at a job that the worker knows will provide only 10 months of world per year, and suppose that this worker makes little or no effort to find other work for the two months each year of temporary layoff. Under our old UI program, if this person is determined to, he or she could probably collect two months of full unemployment benefits each every year during the "off" period. Suppose that the second person works 40 hours per week, 4 weeks per month at only $10 per hour, for all 12 months every year at a UI covered job. This second person earns only $19,200 per year, but will be taxed each year to provide a transfer payment to the first person who has annual earnings of $32,000

Because the first worker in this hypothetical example is not willing to work all 12 months, condition (i) above is violated. This type of violation is difficult to prevent by regulation without intrusive surveillance. Also, the first worker who is receiving the income "replacement" has a better material standard of living than the second worker, even without the benefit payments. Thus condition (ii) is violated. Since higher income workers are only paying UI taxes on their earnings which are below the UI earnings cap, and a lower wage worka like the second one described above must pay UI tax OD all his or her earnings, condition (iii) is being violated as well.

A program that satisfies the principles of fair, user funded insurance can potentially enjoy broad user support because participants are receiving fair value for their premium payments. Inappropriate claims will tend to be automatically discouraged by the way in which future premium rates or coverage levels are adjusted for those who collect benefits. This will help keep the program affordable and will make it possible to run such a program without intrusive investigation, except in unusual cases. On the other hand, for income transfer programs, means testing and ongoing verification of recipient claims are necessary because of the temptations posed by untied transfers of income, and so as to assure those beings taxed to provide this support that the conditions of fairness for an income transfer program are being met.

The old UI program does not satisfy the principles of fair insurance. Yet it has none of the built-in protections against program abuse that experience rating provides in most private insurance programs. In our old UI program, insurance principles, have been ignored on the basis of appeals that many of the program participant genuinely need income transfers. But the old UI program does not satisfy the principles of a fair income transfer program either, and it does not involve family means testing. The means testing that would usually be part of an income transfer program such as welfare has not teem instituted in the UI program on the legitimate grounds that this would be unaccceptable for an insurance program. Our old UI program has been growing out of control and has been losing public support because we have failed to insure that either the principles of fair insurance or the principles of fairness for an income transfer program are adhered to.

I believe a choice must be made, and that insurance principles are the right ones for our UI/EI program. The program covers much of the Canadian workforce, and must continue to have broad coverage if it is to continue to play the important macroeconomic stabilization role it now does. It would be prohibitively expensive and unacceptably intrusive to have means testing for such a large program. Also, many workers who are well off nevertheless want insurance coverage for unexpected spells of joblessness, just as may well off homeowners want and buy homeowners' insurance. Moreover, from a society perspective, the program will be a more effective automatic stabilizer if it provides coverage for all workers -- not just for the working poor.

TO BILL C-12 REFORM

(1) The first is to the proposed switch from using weeks of work at UI covered jobs to using hours of covered work as the main unit of account for the program.

(2) The second is the new intensity rule, whereby the replacement rate for insured earnings would fall with increased use of the program over the previous five years.

My main purpose in this Brief is to explain why I support each of these reform measures.

The move to using hours of work as the emit of account

The first of the three key proposed changes -- the shift to using hours of work as the main unit of account -- is a forward looking provision that will improve program coverage in years to come.

We currently have a program that excludes jobs offering less than 15 hours of work per week. Our old UI program provides a monetary incentive for businesses to take jobs which have been full time and chop them up into mini jobs -- jobs for which the UI payroll taxes are avoided because they are for less than 15 hours per week. The change to an hourly unit of account will eliminate this perverse incentive.

Of course, part time employment is probably on the increase for other reasons as well, and will probably continue to grow faster than full time employment even after the adoption of EI. Under the rules of our old UI program, as the portion of total employment that is part time grows, the program coverage would continue to fall.

When Canada slips into an economic recession, those who are laid off must cut back on their expenditures far more severely if they are ineligible to collect unemployment or earnings insurance benefits. In addition to the damage to them and to their families, the large decreases in their expenditures translate into lower levels of sales and more layoffs. This circular spiral of layoffs leading to sales decreases, which lead to more layoffs, can potentially result in deep economic depression. The value of a UI or EI program as an automatic stabilizer that can help prevent a downward spiral into depression depends on broad coverage. The proposed move to an hourly unit of account will help reverse the erosion of coverage for our UI program due to the increasing numbers of part time jobs that are ineligible under the old program rules.

Finally, this change will lead to greater equity of treatment for part time versus full time workers. This is increasingly important in an economy where growing numbers of workers can only find employment in part time jobs, though they may be working full time when their hours of work on all jobs are counted.

The intensity rule

The 1971 changes to the UI Act set our UI program on a course toward becoming the unwieldy mix it is today of regional equalization and federal welfare transfers in a social insurance program format. It was the changes made in 1971 and subsequent changes in 1978 that enabled seasonal workers with small mmbers of weeks of work to collect UI during the off seasons for their jobs. The number of workers availing themselves of this provision has shown a clear upward trend since 1971.

The intensity rule would help reestablish UI (or EI) as a social insurance program. I use the term social insurance to mean a program that is mandated because it has important social externalities but that nevertheless provides insurance coverage for those paying for the program which represents fair personal value for their money.

It is important to note, however, that having fair insurance coverage is not the same as having individual rainy day accounts that can eventually be used by individuals for other purposes if the insured peril does not occur (or if what was paid in is not fully used to cover peril-related damages for an individual). True insuranec means that those covered by the program who are unlucky and suffer the insured peril can draw out more than they paid in, according to stated rules. But, those who are lucky and never do suffer the peril they are insured against must be satisfied wide having enjoyed the peace of mind of knowing they were insured.

The clawback provisions

If the parameters of the intensity rule were set so as to achieve full experience rating, the UI payroll taxes would then cover the full expected benefits for all categories of beneficiaries. This would be so for upper income UI program participants as well as for those with more modest incomes. With full experienec ratings, there would be no need for the clawback provisions of Bill C-12. However, although the new EI program introduces some experience rating, it is far from being fully experience rated. Under the intensity rule in Bill C-12, the replacement rate only falls from 55 down to a floor of 50 per cent with increased use of the program over a moving five year period. With its parameter values set as in Bill C-12, the intensity rule introduces only a small degree of experience rating into the EI program. It seems unlikely EI will ever be fully experience rated.

The purpose of the clawback provisions if to counteract potential repeat use of the EI program by well off Canadians; repeat use that goes beyond the fair insurance use that these users have paid for. Basically, the clawback provisions makes the program more nearly self policing for higher income participants.

A SOUND PHASE IN STRATEGY

Changes to important public programs inevitably cause apprehension, even when it is clear to most that the changes are needed. People worry about unforeseen consequences, Successfull phase-in strategies for new programs are ways of managing change-related apprehension, and of achieving orderly, efficient change.

In designing phase-in strategies, it is important to recognize the potential value of introducing structural program changes so that, initially, there is minimal change in program impacts. That is, the parameters of new program structures should be set initially so that any changes in program impacts are quite small. Once the new program structures have been accepted, then the program parameters can be adjusted gradually to achieve the desired changes in program financial impacts. This is what is being done in Bill C-12, The Bill introduces major structural changes with modest initial dollar impacts on participants.

Consider the intensity rule in Bill C-12. The Canadian UI program has never before involved any form of experience rating. Thus, it is appropriate to first introduce the intensity rule with a very modest, and delayed, schedule of decline for the benefit replacement rate. This is why the replacement rate only declines to 50 per cent under Bill C-12 and why everyone would be started out in the new program with a figure of zero for use of the program over the previous five years. Once this structural change has been accepted, then, if desired, the steepness of the schedule of decline for the benefit replacement rate can be increased. Similarly, the structural change of moving to hours of employment as the basic unit of account would be implemented under Bill C-12 with parameter values that intentionally will leave eligibility requirements largely unchanged for most program participants.

It is important not to let Finance Department ultimatums about the amount of immediate program "savings" that must be achieved or short sighted business sector disappointment that the immediate UI/EI tax rate reductions are quite small prevent the adoption of sensible phase-in strategies. Some delay in achieving the desired program saving would definitely be worthwhile if this allows important structural changes to be made. This is so even from hard line deficit reduction and business tax relief perspectives.

CLOSING REMARKS

The reform debate over Bill C-12 is highly polarized, width defenders of the nation's financial and business sector health on the one side and champions of charity toward the less fortunate on the other. But those who take the time to understand this complex, carefully crafted bill will find that it addresses important problems with our present UI system that the two sides in the polarized debate have been trying to bring to the attention of the public and political leaders. Bill C-12 addresses these concerns in an integrated, internally consistent manner that takes account of the best available research on the functioning of Canadian labour markets. It is a bill that holds the promise of advancing the interests of both sides, with growing benefits for the economic and social healt of this nation in years to come.

Social Affairs, Science and Technology

Proceedings of the Standing Senate Committee on Social Affairs, Science and Technology