Unemployment Insurance Problems In Your Own Backyard

Did you know that if you hire your neighbor's kid to mow your lawn, you are liable, under Colorado law, for unemployment insurance for that kid?  

The fact is you cannot sell your labor for a price you are willing to accept unless it meets government criteria. As an employee, you must receive minimum wage -- and be covered by Unemployment Insurance (UI), workers compensation insurance, and have taxes withheld. This is how our state and country disrespect individual enterprise. Let's consider how this affects the small businesses that hire most of the people in our land:

In a recent blog I railed against the Unemployment Insurance (UI) system because it reduces private sector jobs.  The system creates a whole slew of perverse incentives, including these:

§       Businesses are more reluctant to hire an employee who might eventually become an unemployment claim that will raise UI tax rates.

§       Employers facing layoffs have an incentive to fire employees for cause so they avoid an unemployment claim.  This damages the work record of the employee, making it harder to find a new job.

§       In 2009, legislation gave The Colorado Department of Labor and Employment (CDLE) expanded powers to investigate businesses for potential “misclassification” of employees.  With the UI trust fund being $500 million in the hole, CDLE has reason not merely to audit for enforcement, but also to coerce businesses into paying taxes they should not owe. 

Employees don’t see a deduction on their paychecks to cover unemployment insurance.  Nevertheless, they pay for it.  In a competitive labor market, a tax paid by an employer is money that could otherwise be used for employee compensation.  Yet few of the employees who pay for UI taxes will ever receive the benefits.  You only get benefits if you become unemployed “through no fault of your own”.  Employers and CDLE both have strong incentives to prevent payment of benefits.  The UI system is of limited benefit and is a drain on job creation and payrolls.  

To me though, the worst part is that the government limits your right to provide labor.  That is exactly NOT the purpose of government.   Government’s role is to protect your property rights, including your right to sell your labor as you see fit.  You might disagree with me about the value of unemployment insurance, but it is indisputable that it restricts liberties. 

There is a class of people who are exempted from these restrictions: independent contractors and business owners.  If you want to mow your neighbor’s lawn for money, or design a software system for him, you can become a business owner.  Your neighbor won’t have to withhold taxes, buy worker’s compensation insurance, or pay UI taxes.   

But there’s a catch. Colorado law has a list of nine criteria that you must meet to be a valid independent contractor. If you don’t meet all nine, your neighbor will be liable at least for UI taxes.  It is solely the judgment of the auditors from CDLE that determines if you have met those criteria.   

In a recent audit, the auditor interpreted the rules to mean that if an independent contractor gets more than 50% of its revenue from one business, it could be reclassified as an employee and be subject to back taxes, interest and penalties. Such a ruling, were it applied universally, would be totally impractical.  A new contractor could not go into business until it had secured at least two contracts, each for half of its business.  An enterprise would be precluded from doing more than 50% of its business with its best customer.  

The criteria are vague and arbitrary. They lead to abuse by the CDLE who are empowered by the 2009 legislation to enforce the criteria in any way they see fit for the purpose of supporting a UI system that reduces job creation, damages resumes, and robs individual liberties.   

The legislature must change the law to loosen the restrictions on independent contractors. There is only one criterion that is not arbitrary and open to interpretation by unelected and unaccountable bureaucrats: the willingness of an individual to become subject to the risks of business ownership. By expanding the definition of independent contractor, more people will be able to opt out of the failed unemployment insurance system.

Who Pays For Unemployment Benefits?

Imagine you just interviewed for a new job. The employer tells you “You’re a great match for our company, and we’d be excited to have you work for us. We offer good pay, flexible hours, a comfortable work environment, and great benefits.” 

You say, “Great! When can I start?”

“Unfortunately, our benefits are so great, that we can barely afford them for the people we already have. So even though we’d love to have you work for us, we can’t afford to hire you.” 

You reply, “I don’t need all the benefits. I really need the job.” 

“Unfortunately, the benefits are mandated by government, so our hands are tied. Best of luck to you with your job search.” 

In Colorado (as of October, 2010, the latest information my research team (me) could find) every 95 people that receive wages represent one job that won’t be created because of unemployment insurance (UI) taxes.  That means those taxes potentially increase unemployment by 1%. And those taxes are increasing rapidly, so 95 people may soon become 75 or 65, and 1% becomes 1.3 or 1.5%. 

During this recession, Colorado’s Unemployment Insurance Trust Fund (UITF) has been bankrupt since January, 2010. Colorado pays $1.51 in benefits for every $1.00 it receives in UI taxes.   Despite our state constitution’s ban on deficit spending, the UITF has been borrowing money from the federal government since then.  We are currently $500 million in the hole.  Unemployment Insurance taxes are going up to cover the deficit, and with fewer businesses and employees to tax, the rates are skyrocketing. 

Our unemployment system creates huge problems. First is the incentive not to hire. Every new hire is a potential unemployment claim against the employer. Claims raise rates.  It’s better not to hire someone you may later have to lay off.  Second, employers are inclined to fire “for cause” if layoffs are necessary, so that the employee will not be able to make a claim against the company. This damages the resume of the new job seeker. 

But aren’t the benefits worth it? The Congressional Budget Office (CBO) says of the options it studied for government programs to stimulate the economy, UI is the most effective.  It also says that every dollar spent on unemployment generates up to $1.90 in economic growth.  This is preposterous on its face.  If it were true, we could all quit work and the economy would not just recover, it would flourish.

One option the CBO ignored is not taxing employers and not borrowing money to pay for the benefits.  If a dollar taken from an employer by the State and then redistributed to a beneficiary (who spends valuable but unproductive time to meet the State’s requirements) can generate positive economic growth, then a dollar left in the hands of an employer surely would generate more growth.  

Contrary to popular opinion, employers do not pay UI taxes. Sure, they write the checks. But the money comes from you and me, the workers, consumers, shareholders, etc.  UI taxes (as well as any other tax) are a cost to the business, and the business passes those taxes on.  If they don’t or can’t, that leads to fewer profits, business failures, and lost jobs. But if the business you work for fails, you’ll get unemployment benefits! That should make you feel better – you’ll be a beneficiary of the tax that added to the burden that led to the failure of your employer! 

And who gets the benefits?  The government and business both have incentive to deny claims to unemployed people.  Claims increase the experience rate of companies, and that raises their tax rates. Businesses will do their best to terminate for cause so that claims will not be paid.  Colorado government wants to display their “fiscal responsibility” by running a sound program that doesn’t run out of money and eliminates fraud and abuse.  So a relatively small percentage of those who lose their jobs actually receive the benefits.  Even now, only 37% of the unemployed receive benefits. 

So when you go to that next job interview, look at the employees.  Every 95 of them represents the job you won’t get, courtesy of your government.