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The macro-economics of financing employment insurance

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The federal government has launched consultations on EI premium setting. This provides the opportunity to shift from a very ad hoc system to one that is more fair to workers, and more economically rational.

The current worker premium is $1.78 per $100 of insured earnings and the employer premium is $2.49 per $100, adding to a total premium of $4.27 per $100 of insured earnings. EI premiums are paid on earnings up to an annual maximum of $44,200.

Premiums are, under current rules, set to rise by 24 cents per $100 of insured earnings each year between now and 2015-16. (The increase in the worker premium will be 10 cents; employers pay 1.4 times the worker premium.)

Most economists view premium increases during a period of weak recovery and continued above average unemployment as damaging to growth and employment. While payroll tax increases are borne by labour over the medium to long-run such that the impact on employer hiring decisions is very limited, an increased employer tax at a time of higher than average unemployment may have some modest negative impact on hiring. And higher worker premiums will lower consumer spending.

Unlike a gradual increase in CPP premiums to pay for higher future pensions, higher EI premiums provide no additional benefit to workers, and are being imposed even though large surpluses were accumulated in the EI Account before the recent recession. In the mid 1990s, the Chief Actuary for the EI program calculated that a $15 billion reserve fund would be sufficient to pay for the additional costs of a recession, but the "old" EI Account accumulated a total surplus of $57 billion before it was eliminated in 2008.

It is often argued that EI revenues and expenditures should balance over the business cycle. However, this is a difficult principle to operationalize since the cycle can only be identified with hindsight. We had no recession for a very long period from the early 1990s to 2008, and we may yet see the economy fall back into recession in 2011 or 2012.

In any case, the norm in Canada is for the macro-economic stabilization role of EI to be undermined on the revenue side. While benefits appropriately increase during recessions, the stabilization role has, in the past, been significantly offset by premature premium increases. Premium rates increased sharply in the immediate aftermath of the recessions of the early 1980s (from 1983) and 1990s (from 1990) and are now increasing again.

Under the so-called "new" premium-setting mechanism put in place in 2005 which continues today, the rate is set so as to balance forecast premium revenues and forecast program expenditures (including administrative costs) on a forward-looking basis for the coming year, ignoring past surpluses. The economic forecast and the program expenditure forecasts which determine the forward-looking premium rate are provided by the Department of Finance and the Chief Actuary for EI, and the Chief Actuary calculates the needed premium rate. However, the legislation capped annual EI premium changes at 15 cents per $100 of earnings (lowered to 5 cents in 2011 and 10 cents moving forward), and the government retains the right to set the premium rate as it did in 2010 when the rate was frozen.

The Canadian Employment Insurance Financing Board (CEIFB) which now sets the premium began its life in 2008 with a very large EI Operating Account accumulated deficit, forecast to be $10.4 billion at the end of 2011. There is expected to be an annual deficit in the Account of $1.9 billion in 2011, since the current premium rate of $1.78 (this is the worker, not total premium) falls well below the estimated break-even rate of $2.68. On the basis of EI benefit and revenue forecasts in the 2011 budget, it can be projected that the accumulated operating deficit will not be eliminated until 2016.

While the federal government directly covered the cost of the EI measures in Canada's Economic Action Plan (including the cost of the premium freeze during the recession; training benefits; work-sharing; and the temporary five-week extension of regular benefits), the EI Operating Account went into deficit because of the large increase in the cost of regular EI benefits caused by the increase in the national unemployment rate from about 6 per cent before the recession to a high of 8.6 per cent in 2009, and continuing high unemployment since the worst of the recession.

Notwithstanding the rule that premiums should have increased by the maximum of 15 cents to balance the EI Account moving out of the recession, the government froze the premium rate for 2010, increased it by just 5 cents for 2011, and has set the maximum increase at 10 cents for 2012 and subsequent years.

While some flexibility has been shown, the EI financing system now in place is still not operating in an appropriately counter-cyclical way. Premiums are now rising during a very weak recovery, and would have to rise by even more if we were to enter a new recession. This is the case notwithstanding the fact that the "old" EI Account eliminated in 2008 had a $57 billion accumulated surplus. This was the result of large annual surpluses run by the Liberal government from the mid 1990s when benefits were cut and the EI premium was essentially turned from a tool supposedly balancing EI revenues and expenditures over time into a payroll tax to eliminate the deficit and lower the debt.

The Canadian Labour Congress has said that a new system of financing should stop premiums from increasing significantly until there has been a meaningful economic recovery, and should take into account the fact that a large EI surplus was accumulated before the current recession.

We have proposed that the annual premium rate should be set annually to cover the anticipated costs of the program (including both regular and special benefits) in the coming year at a national unemployment rate of 6.5 per cent. This would be approximately equal to the current premium; though the precise amount would vary a bit moving forward due to the anticipated costs of special benefits, employment benefits and special measures, administrative costs, pilot projects, and any legislated changes to benefits. As was the case in the early 1970s, the government should bear the additional costs of higher than normal unemployment, at least until such time as a reserve fund has been established.

6.5 per cent was the average national unemployment rate in the five years -- 2004 through 2008, before the recession -- and can be considered a "normal" unemployment rate.

When and if the national unemployment rate falls below 6.5 per cent, the CEIFB could begin to build a segregated reserve account of sufficient size to cushion the federal government's finances if the national unemployment rate were to again rise above 6.5 per cent.

This article was first posted on The Progressive Economics Forum.

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