Unemployment Insurance Taxes and the Cyclical Properties of Employment and Unemployment

The US unemployment insurance system is financed by an experience-rated payroll tax. The system imposes a layoff or firing cost on employers, leading them to fire fewer workers in a downturn and hire fewer workers in an upturn. Increases in the degree of experience rating are therefore predicted to reduce the temporary layoff unemployment rate in a recession, and to lower employment at the peak of the business cycle. We combine Current Population Survey data for l979-1987 with a newly assembled database of experience rating factors for individual states and industries to measure the effects of imperfect experience rating on temporary layoff unemployment rates over the cycle. We find a strong negative correlation between the degree of experience rating and the rate of layoff unemployment in recessionary years, but smaller and unsystematic correlations in expansionary years. We also find that cyclical employment fluctuations are dampened in states and industries with a greater degree of experience rating.