Insurance principles offer three practical reforms for financing Employment Insurance

The Canadian federal government has promised to modernize Employment Insurance for the 21st century and has been holding consultations to engage stakeholders and others. These have been full of suggestions for the expansion of coverage and benefits. But when it comes to financing the program the debate has been framed in terms of how to finance these suggestions, without a realization that the nature and structure of contributions are themselves also a part of the “modernization” of Employment Insurance.

There is a clear need to think not just about how to finance benefits by adjustments and tweaks to the existing contribution structure, but rather to also think about that structure and how it can itself be reformed to enhance program objectives.

The need for better insurance offers a guiding principle for reform and practical reforms

The challenges the Employment Insurance has faced during what is almost the first quarter of the 21st century, if not for even a decade longer back to the early 1990s, are calling for better insurance, and these imply changes not just to the structure of benefits but also to contributions.

The most fundamental role of Employment Insurance is to provide workers with income insurance during periods of job disruption, and it is the insurance part of Employment Insurance that needs upgrading and modernization. As a result, a guiding insurance principle for “Modernization” should be to align the structure of contributions to the underlying nature and causes of the risks being covered.

This implies that contributions should be structured to most efficiently and equitably to cover:

  • Job risks associated with employer decisions to manage human resources, whether through changes in hours, layoffs, or even business closures;
  • Family risks associated with household decisions about respite, care-giving, and skills development; and
  • Collective risks associated with the interconnectedness and uncertainty of a global economy, but also with social choices, the costs of which are often disproportionately shouldered by the unemployed.

Aligning contributions with these risks, with the nature and causes of unemployment, implies three straightforward and feasible reforms.

  1. Employer contributions should be used to finance Regular Benefits, and employee contributions should finance “Special” Benefits and some fraction of Part II benefits associated with skills development. The shares of total program expenditures of each of these benefits implies that the ratio of employer to employee contributions should rise from $1.40 for every dollar of employee contribution to about $1.90. But these contribution rates should also evolve gradually over time by being based on the ratio of program expenditures on Regular Benefits to those on Special Benefits. If Special Benefits become a larger share of total Employment Insurance outlays, the employee contribution share should rise accordingly.
  2. Contribution rates should be relatively stable and set at a level to finance benefits associated with the underlying trend unemployment rate, evolving gradually in a way that roughly corresponds to the evolution of frictional and structural unemployment. An average of monthly unemployment rates over the past seven years, a horizon consistent with the current funding rules, would currently imply a trend unemployment rate of 7%. An average over the past five years, consistent with the usual mandate of a newly elected government, would imply the same. This is only slightly higher than the 6.5% that both rules implied in January 2020, before the onset of the pandemic, and suggests relatively constant rates even in the aftermath of a shock as big as the pandemic.
  3. The program should be based on tripartite funding with Federal government contributions from the Consolidated Revenue Fund covering the expansion of benefits needed in the face of big unexpected shocks like business cycle downturns and broad-based regional shocks that take the unemployment rate above its trend, or to compensate for the trade-offs made in social choices like fighting inflation. At the same time, the Federal balance sheet should be strengthened by the surpluses associated with lower than trend unemployment rates.

[ This post is based upon a presentation I made to a workshop organized by the Institute for Research on Public Policy on June 29th, 2022. My presentation was called “Principles and Practicalities in aligning Employment Insurance Benefits and Contributions”.

You can download and read the full paper that summarizes the presentation, and upon which this post is based. You can also read short summaries published by the CD Howe Institute on October 11th, 2002 as “Insurance Principles Make the Case for Stable Contribution Rates as a Part of Employment Insurance Modernization,” and on October 12th, 2022 as “Reality-based Employer EI Contributions.”

A version of this post was also published by the CD Howe Institute on October 13th, 2022 as “Insurance principles offer three practical reforms for financing EI.” ]

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