Fed Working Paper: Pandemic unemployment benefits protect incomes, helped reduce inequality, with limited work disincentives
Fed Working Paper: Pandemic unemployment benefits protect incomes, helped reduce inequality, with limited work disincentives
A new working paper from the Federal Reserve Bank of San Francisco finds that the historically unprecedented expansion of unemployment insurance (UI) benefits in the U.S. during the COVID-19 pandemic offset rising income inequality with only moderate impacts on job search behavior.
Why it matters: The findings suggest that UI benefit enhancements during economic crises can substantially protect incomes without significant adverse consequences for economic efficiency. This has important implications for policy responses to future downturns.
The details: Using tax data to correct for severe underreporting of UI income in survey data, Federal Reserve economists Robert Valletta and Mary Yilma find that UI payments in 2020-21 almost wholly eliminated the increases in household income inequality that would have occurred otherwise due to the pandemic's uneven economic impacts.
Without UI payments, median real household income would have fallen by over 6% in 2020, and inequality would have surged, especially in the bottom half of the income distribution. The UI enhancements neutralized these effects.
The bottom-half income inequality increases that UI payments prevented were driven by disproportionate pandemic job and earnings losses for low-wage workers in hard-hit industries like leisure and hospitality.
A $600 per week UI benefit supplement from late March to July 2020 raised UI replacement rates (weekly benefits as a share of prior earnings) to a median of 134%. But overall, job search disincentive effects were moderate for a few key reasons:
Despite UI benefits often exceeding prior earnings, especially for low-wage workers, the average job search reductions in response to the higher UI replacement rates were relatively small. A 10 percentage point increase in the replacement rate reduced job-finding rates by around 0.5 percentage points.
The job search disincentive effects were more pronounced among UI recipients from higher-income households than those from lower-income families. Even though UI benefits replaced a larger share of prior earnings for low-wage workers, this was the case.
The limited job search response for low earners likely reflects the fragile labor market conditions they faced in the early pandemic when many services businesses faced mandatory closures or restrictions. Some earlier research has found smaller job search responses to UI benefits when the labor market is weaker.
Background: The CARES Act passed in March 2020 raised weekly UI benefits by a flat $600 through July, more than doubling typical amounts. Maximum benefit durations grew from 26 to as high as 75 weeks. Eligibility was extended to self-employed and gig workers. The $600 supplement expired in July 2020 and was renewed at $300 for parts of 2020-21.
The bottom line: The unprecedented pandemic UI enhancements successfully insured recipient incomes and reduced the inequality impacts of the uneven downturn, with limited efficiency costs from reduced job search concentrated among higher earners. Tying UI benefit increases to economic conditions, such as the unemployment rate, during downturns warrants consideration.
What to watch: Whether the pandemic UI experience informs future policy responses to economic crises and downturns, leading to more robust and equitable income support with built-in triggers. Addressing the inequalities that made the pandemic so uneven in the first place is also a key priority.
Our Notes: The Federal Reserve study's findings on the inequality-reducing and income-protecting effects of enhanced unemployment benefits during the pandemic align with and reinforce other recent research we have reported.
For example, one study found that despite initial fears, fertility rates in California remained surprisingly stable during the pandemic. This may partly reflect the role of expanded social support like unemployment insurance in reducing economic insecurity.
Similarly, cross-country research has shown that Denmark's generous unemployment insurance scheme better protects fertility rates during economic downturns than less robust UI programs in other countries.
Together, these studies suggest that strong unemployment insurance and other safety net programs can help maintain economic stability and promote longer-term well-being for households during crises, reducing the risk that temporary shocks cause lasting damage. The unprecedented UI expansions during COVID-19 in the U.S. likely played a key role in the unexpectedly quick economic recovery. They help prevented a massive drop in fertility rates until the program ended.