Stimulating the Stimulus—unemployment compensation

By :: February 6th, 2009

The stimulus bill before the Senate would exempt from income tax the first $2,400 of unemployment compensation that people receive in 2009. Because the exclusion reduces their taxable income, higher bracket taxpayers get a bigger break than those with lower incomes. And very low-income households that have no tax liability would get no benefit at all.

The exclusion has two aims: boost after-tax income for people who have lost their jobs and give money to those most likely to stimulate the economy by spending it. But because it mixes the progressivity of the income tax with increasing benefits, it falls short.

Losing your job doesn’t necessarily consign you to poverty. The accountant who loses his $50,000 job won’t suffer much if his surgeon wife still earns $400,000. Not taxing $2,400 of his unemployment compensation saves the family $780 (35 percent of $2,400) but is unlikely to affect either the family’s consumption or well-being. But the single person who loses her $16,000 job would save at most $240 (10 percent of $2,400). She’d likely spend it all and still not be significantly better off. And the single parent who pays no income tax would get nothing.

The stimulus bill passed by the House already contains a better idea—boost every unemployed worker’s compensation by $25 a week, paid for by the federal government. CBO says that will cost $5 billion in 2009 and another $4 billion in 2010. It avoids tying an increase in benefits to tax rates and spreads benefits evenly among all beneficiaries.

So why not drop the proposed tax break and use the $4.7 billion saved to double the 2009 addition to weekly benefits to $50? The hit on the federal budget would be about the same and the extra benefits would help every job loser including those that pay no income tax. In normal times, we’d worry that higher benefits would slow the pace at which the unemployed find new jobs but these aren’t normal times and new jobs are scarce. The added funds would almost certainly be tilted more toward lower income households who would spend more of the extra income. Not only would this alternative better distribute aid to needy households but it would also pack a bigger economic stimulus.