All Commentary
Thursday, May 1, 1986

Unemployment Compensation

To compensate workers for wages lost during periods of unemployment, most countries have systems of unemployment insurance. They are compulsory, in the sense that government enforces coverage and uses the taxing power to finance the expenditures. Previous contributions by or on behalf of the workers largely determine benefit eligibility and amounts according to formulas stipulated by law.

The primary purpose of the system is economic assistance and compensation of employees for wage loss during periods of economic decline and depression. The economic effects of such periods are compounded by sociological effects that are reflected in physical and mental ill health, rising crime rates, divorce rates, and even suicide rates. Unemployment compensation seeks to alleviate the ill effects.

The American system is a federal-state system that was forced upon the states by the Social Security Act of 1935. The Act levied an unemployment tax on employers, but offered a 90 per cent offset (I) for employer payments of state payroll taxes for unemployment benefits or (2) for reductions in such state taxation under a program of experience ratings. The law left the states free to determine their own benefit levels and duration of benefits. Consequently, benefit provisions and tax rates differ widely among the states.

The system is a form of public charity that springs from a new conception of social welfare. The public now accepts the concept that government must bear the ultimate responsibility for public relief, including unemployment assistance. This new attitude brought forth extensive social legislation and led the way to the “welfare” or “social service” state. The American system followed in the footsteps of earlier systems in Scandinavian countries, some Commonwealth countries and Great Britain, which in turn were influenced by the labor legislation of Bismarck Germany in the 1870s.[1]

The social service state has few genuine critics. Its countless supporters are guided by a great number of motives that continue to lend intellectual support to the system. Their first and foremost motive, we are led to believe, is charity toward their fellow men. They wax eloquent about their feelings of benevolence, good will and affection, indulgence and forbearance. In the name of charity they call upon government to cater to the needs of the people. Government is to assure a system of social assistance, to grant every citizen the right to extensive welfare benefits, unemployment compensation being just one of them, so that everyone may achieve maximum cultural and even spiritual well-being.

A few critics are highly suspicious of this attitude that makes government the guardian of charity and welfare. Some are guided by Judeo-Christian principles that make charity a responsibility of each and every individual. To them, private initiative and charity are the keys to American progress and prosperity, having led to unprecedented improvements in working and living conditions. They look upon private charity as an important bulwark against complete state control and the political command system, which they abhor for many reasons.

The welfare state as a transfer state is an early form of the command system, appealing to envy and covetousness and, by creating classes of beneficiaries and victims, continuously breeds social conflict and strife. It is driven by government coercion and guided by majority vote. It is never fair, but always political. It is cumbersome and slow, unable to act promptly and efficiently.

An Automatic Economic Stabilizer

The Judeo-Christian command of charity is no call for politics. Unemployment compensation is the product of politics. its supporters may concede the point, but they hasten to defend the system on grounds that it is a desirable economic stabilizer that moderates the business cycle. They applaud it as an important countercyclical force that injects purchasing power when unemployment rises and absorbs it when unemployment fails again. It is said to stabilize the propensity to consume and thereby acts in a countercyclical, stabilizing way.[2]

In his popular textbook, Economics, Paul A. Samuelson applauds unemployment insurance and other welfare transfers as “a first line of defense” that goes into action automatically to counteract a recession. “Unemployment insurance pumps funds into or out of the economy in a countercyclical, stabilizing way. Similar features are seen in many income support programs. Food stamps, aid to families with dependent children, and early retirement on Social Security are examples of public transfer payments that help to shave the highs and lows from the business cycle.”[3]

It is difficult to fathom the operation of the Samuelson pump that moves funds into and out of the economy. Unemployment tax revenues do not move in and out of the economy. They are levies imposed by politicians and collected by internal revenue agents, exacted from employers who in turn obtain them from the productive labors of their employees. Civil servants then disburse the funds to some unemployed workers. If there should be a temporary surplus, the U.S. Treasury spends it, issuing IOU’s in the form of U.S. Treasury bills and notes. If there should be a shortfall, the taxes are likely to be raised to the level of expenditures. One searches in vain for the pumping action that causes the funds to exit from the economy, remain hidden for a while and then to return to active duty.

The only pump at work is a transfer pump that reduces the paychecks of working employees while it yields benefits to unemployed workers and salaries to civil servants who operate the pump. Contrary to popular belief, payroll taxes do not seize employer income. They do not reduce entrepreneurial profits or capital interest or managerial remuneration. Every penny exacted on behalf of employees is taken from employees through lower take-home pay. Lower take-home pay offsets the unemployment tax. The levy does not cause unemployment, but it continues to prevent saving and investing, which would raise labor productivity, bolster the demand for labor, and reduce unemployment.

No pump on earth can prevent the business cycle or moderate its effects. No food stamps, no aid to dependent children, no early retirement on Social Security can prevent the cycle once it has been set into motion through inflation or credit expansion. No matter what else government may contrive or attempt, easy-money policies bring about economic booms that cause business misjudgments and maladjustments. Once a boom has run its course it necessitates and brings forth a depression which is a period of readjustment. There are no miracle cures for business cycles, no recipes for full employment. Government cannot “fight” depressions through more easy money and more transfer payments. It can, however, prevent them by abstaining from the policy that causes them: inflation and credit expansion.

To embark upon pumping action at any stage of the cycle is to make matters worse. During the boom it may add to the maladjustment, during the recession it may delay the readjustment. Unemployment taxation, like any other taxation and government intervention, does not counteract the business cycle. It aggravates the disorder.

New unemployment levies are forced exactions to which the labor market has not yet adjusted. They boost labor costs and temporarily reduce employer income. Governments usually impose new levies either through higher rates or higher bases, or both, at the very moment of business difficulties, during the depth of depression. The exactions compound the situation by lowering the productivity of labor even further, thus reducing the demand for labor and boosting unemployment. They continue to have a painfully contracting effect until the take-home pay has fallen by the amount of the new tax exactions. Unfortunately, organized labor tends to resist the reduction, which aggravates the unemployment. Workers are led to lay the blame for rising unemployment on employer greed and the private property order rather than on the tax boosts and their own reluctance to adjust to the boosts.

Skills and Training

Unemployment taxation and compensation may not encourage capital formation, but they are said to promote the preservation of skills and training. With their eyes glued on the output of the transfer pump, and completely ignoring the pump input, as well as the energy it takes to operate the pump, the popular champions of unemployment compensation view it as an auspicious outpouring that preserves given skills and training and thereby safeguards labor productivity. They favor generous compensation because it reduces the financial pressures on the unemployed to accept different or lower-level jobs.[4]

Surely, it is a grievous fallacy to contend that unemployment is more conducive to maintaining skills and training than work on any level; that it is more beneficial to finance idleness than to encourage the unemployed to accept lower-level jobs; that society is better served by mass unemployment than lower-level production. Work on any level usually broadens skill and ability and adds valuable experience that improves individual productivity. It is presumptuous to contend that there is no learning except on one’s own level of skill and expertise.

The skill- and-training argument completely ignores a fundamental characteristic of the private property order, which is continuous change and readjustment of production to the wishes of consumers and to the ever- changing state of technological knowledge. Capital and labor must adjust continuously; failure to adjust inflicts losses and causes unemployment. The chronic unemployment of some eight million Americans, which most observers are quick to place on the doorsteps of the business cycle, must be charged primarily to the very policies that prevent and discourage change and readjustment, from minimum wage legislation to the legal privileges of labor unions. Unemployment compensation that encourages preservation of old skills and discourages new learning and new skills aggravates and prolongs the chronic unemployment.

The reluctance to adjust to changes and acquire new skills may rest on individual apathy, sloth or just fatigue. But it may also spring from the notion that many unemployed workers have great skills and training that need to be preserved with the help of generous unemployment compensation. This is a popular error. The pains of unemployment are felt most frequently by the least productive members of society; they suffer a common fate because government or labor unions, endeavoring to raise their pay and benefits, manage to price them out of their jobs. Surely, the unemployment rate among minimum wage workers, steel workers and automotive workers, most of whom have minimal skills, training and education, is measurably higher than in any other vocation.

Employee Disincentives

In the United States the existence of separate state systems makes for competition that reveals some startling contrasts. The high-benefit states are the high-unemployment states. The low-benefit states are the low- unemployment states. Low benefits, severe conditions and disqualifications, and the resulting low tax rates, seem to attract new industry and promote economic expansion, which provide new opportunities for employment. High benefits call for high taxation which, going higher and higher, may hamper business and breed unemployment.

The trends of unemployment are predictable, being subject to various influences and controls. Monetary, fiscal and foreign-trade policies affect the productivity of labor and consequently the demand for labor. The level of unemployment benefits has a significant impact on worker incentives and the supply of labor. Recent growth of the benefit provisions of the unemployment compensation system as well as public assistance benefits has significantly reduced the supply of labor. It subsidizes unemployment and thereby breeds more unemployment.

Acting man always faces a choice in allocating his resources among alternative uses. In this case he must allocate his time among alternative uses. He may use it in production (work) or in consumption (leisure). The mode of allocation generally depends on the relative prices of both: a rise in the price of one relative to the price of the other tends to lead to a decrease in its consumption; a falling price tends to increase consumption.

Unemployment benefits reduce the cost of leisure and encourage the withdrawal of some labor from the labor market. New benefits and extensions of old benefits reinforce the withdrawal, which is hidden in the thicket of rules and regulations that seek to deny workers the freedom to choose between work and leisure. Withdrawal from the labor market obviously assumes freedom of action and voluntary reaction to changes in the relative prices of labor and leisure. Unfortunately, institutional restriction and prohibition often deny individuals the freedom to choose. Many individuals are barred from participation in production and exchange by such barriers as minimum wage legislation and license and permit requirements, which causes some workers to seek refuge in the underground economy. But most workers still have the choice between labor, which is regulated and taxed severely, and leisure, which is subsidized generously with unemployment compensation and other benefits of the transfer system. It cannot be surprising that many workers prefer the joys of leisure over the disutilities of labor.

Over the long run, aggregate unemployment rates have been rising in the United States. They have been increasing almost exclusively among unskilled or semiskilled laborers for whom the difference between the market wage of labor and the unemployment compensation and other benefits is minimal. A worker who earns $200 net per week for his labor exertion and $200 in the form of unemployment compensation and many other subsidies from food-stamps to Medicaid, lacks any pecuniary incentive to labor. He lacks the incentive to accept employment at a market rate of wage that may be lower than his compensation rate. He may prefer to remain unemployed until the benefits run out.

According to Department of Labor statistics, some seven to eight million Americans are unemployed. More than thirty million live in retirement and receive Social Security benefits. More than nine million depend on survivor benefits. Over six million live on public assistance or supplemental income. Altogether more than fifty million non-work-ing Americans depend on transfer payments for their support. Surely, their number significantly reduces the supply of labor throughout the American labor market and renders the remaining labor more expensive. Not only does it deprive working people of the transfer income that is forcibly taken from them, but it also denies them the productive contribution many transfer beneficiaries could be making.

Society is substantially poorer because millions of able people no longer contribute to economic production, in recent decades American society has grown visibly poorer in the services which unskilled and semiskilled workers usually render. Many are idle, living on unemployment compensation and public assistance.

An Invitation to Deceit and Fraud

To limit the demand for its offerings, the system imposes benefit conditions that are designed to deny the leisure option. To be entitled to benefits, a person must be ready, willing and able to work. He must be unemployed through no fault of his own. Benefits are denied if he quits his job without a valid reason, is discharged for willful misconduct, refuses to apply for or accept any suitable work within a reasonable distance of his home, or attends a school or training course. The amount of benefits may be reduced if he is self-employed or has any type of earning.[5] Unfortunately, the conditions are rather ineffective, and breed deceit and fraud on a massive scale.

For example, it is difficult to estimate the number of beneficiaries who labor in the underground economy and who blithely forget to report their earnings. But failure to report is tantamount to fraud, which is deception practiced deliberately in order to secure unlawful gain. The unemployment compensation laws call for prosecution of anyone making false statements or knowingly withholding information to obtain benefits illegally. But few such cases appear in court and even •fewer judges are prepared to impose the penalties.

Beneficiaries are expected to apply for and accept any suitable work within a reasonable distance of their homes. But many who prefer leisure over work use imagination and ingenuity, resorting to clever tricks and artful dodges that meet the requirements of application but avoid being offered a job.

Similarly, to quit a job without valid reason or to be dismissed for willful misconduct means forfeiture of benefits—at least, the law•so stipulates. In reality, unemployed workers may cite a great many reasons that may be true, imagined, or even manufactured. The system officials passing judgment on the valid reason or willful misconduct usually concur with the workers and dispense the benefits. Employer efforts to protest and appeal the decision are so costly it is often easier to accept the decision, right or wrong.

Some states deny unemployment compensation to strikers on the assumption that strikers voluntarily leave their jobs and are unavailable for work. However, other states, especially in the Northeast where the labor union ideology is dominant, manage to pay strikers on grounds that they do not leave voluntarily, but are driven out or locked out. When the United Steelworkers struck Wheeling-Pittsburgh Steel Corporation, operating under Chapter 11 of the Federal Bankruptcy Code in an effort to reorganize $514 million in debt, Ohio’s Bureau of Employment Services ruled that Ohio strikers were locked out and, therefore, entitled to benefits.[6]

The effects of this policy are clear. Workers throughout the state suffer reductions in take-home pay so that the United Steelworkers of America, who earn nearly twice the rate of the average worker, can exact more income and wealth from company creditors and stockholders. The subsidy aggravates the strike and magnifies the company losses, which consume business capital, reduce the demand for labor and cause more unemployment.

Moreover, the benefits may necessitate boosts in unemployment taxation, which raise labor costs and reduce the demand for labor throughout the state. Unemployment is bound to go higher throughout the Buckeye State. The payment of benefits to strikers makes a farce of the provision that workers must be unemployed through no fault of their own. If strikers who are noisily manning picket lines and forcibly barring other workers from going to work, are said to be unemployed “through no fault of their own,” then worker fault has practically been eliminated and all fault been placed either on the doorsteps of employers or the economic system itself.


The high unemployment that is persisting in the United States has given rise to a vigorous debate as to its causes and potential cures. On the one hand are those observers who argue that the high level of unemployment reflects primarily a deficiency of aggregate demand. In the footsteps of John Maynard Keynes, they contend that higher and more rapidly rising levels of spending, including unemployment compensation and public assistance, supported by appropriate monetary and fiscal policies, can bring unemployment down to a satisfactory rate of four per cent or less.

Opposing this orthodox view is the economic argument that there is no lack of jobs in an unhampered labor market. Unemployment springs from extraneous force, in particular, by government and labor unions raising the cost of labor above its productivity. Numerous laws and regulations seek to bestow popular benefits, reduce effort and output, and erect obstacles to labor adjustments to changing costs and opportunities. Government and labor unions make the labor market a long obstacle course for unskilled and semiskilled workers. Unemployment compensation is one such obstacle. []

1.   Ludwig von Mises, Omnipotent Government (Spring Mills, Pa.: Libertarian Press, 1985), p, 158 et seq.

2.   Unemployment Compensation in Pennsylvania, Commonwealth of Pennsylvania, Department of Labor and Industry, UCP-19, REV 6-84.

3.   Paul A. Samuelson and William D. Nordhaus, Economics, 12th edition (New York: McGraw. Hill Book Co., 1983), p. 175.

4.   William Haber and Merrill G. Murray, Unemployment Insurance in the American Economy: An Historical Review and Analysis (Homewood, III.: Irwin, 1966).

5.   Pennsylvania Unemployment Compensation Handbook, Commonwealth of Pennsylvania, Department of Labor and Industry, Office of Employment Security, UCP-1, REV 11-80, p, 2.

6.   The Wall Street Journal, September 3, 1985, p. 14; 4.

  • Hans F. Sennholz (1922-2007) was Ludwig von Mises' first PhD student in the United States. He taught economics at Grove City College, 1956–1992, having been hired as department chair upon arrival. After he retired, he became president of the Foundation for Economic Education, 1992–1997.