Federal government should reform the employment insurance system instead of increasing EI premiums

Late last year, Prime Minister Stephen Harper pledged that his government “won’t be raising taxes.” So much for that promise; Canadian workers and employers recently learned they will be facing higher employment insurance (EI) premiums (aka payroll taxes) on January 1, with further increases to come.

The EI premium increase was recommended by the Canada Employment Insurance Financing Board, which is mandated with setting EI premiums to ensure the program breaks even over time. After being frozen since 2009, EI premiums will need to rise over the next several years to help cover the significant increase in EI benefit payouts that resulted from the recession and a host of temporary changes that made EI more generous.

While the Conservatives have limited the EI premium hike to a third of that recommended by the financing board, an increase is still an increase. To fulfil its no-tax-increase promise, the government should reduce taxes elsewhere and seize the opportunity to reform our employment insurance system.

To offset the EI premium increase, the Conservatives should consider personal income tax reductions in the coming 2011 budget. This would ensure that the total tax bill does not increase and produce a change in the tax mix that would strengthen economic growth.

There is overwhelming evidence that different taxes have different economic effects and personal income taxes have been shown to be more economically damaging than payroll taxes. The federal Department of Finance’s own research concludes that raising an extra dollar in taxes through personal income taxes costs the Canadian economy an additional $0.56 in lost output compared with $0.27 for payroll taxes.

More fundamentally, the Conservatives should take the opportunity to reform the EI program to reduce the burden on workers and employers in the future. While several options are available, at minimum the government should ensure that the EI program truly provides an insurance function for labour-market participants.

One option for reform is to use experience rating. Under such an employment insurance scheme, premiums and benefits vary depending on occupations and regions. For instance, individuals in occupations with high risk of job loss and who are thus more likely to draw benefits from the system, pay higher premiums (or receive lower benefits), while those in low-risk occupations pay lower premiums. With experience rating, businesses that regularly game the system by temporarily laying off workers and rehiring them later would pay more.

Indeed, the EI reforms enacted in the 1990s (and unfortunately removed in 2001) show that experience rating helped reduce program expenditures.

Another option is to consider switching to a system of individual unemployment accounts. Here, workers pay premiums into their own account, which is portable between jobs. The money in the account can only be used to finance the worker’s needs during periods of unemployment. For those who make little or no use of the account over their work life, they can use any excesses for retirement. Such a system would strongly reduce the distortions to decisions regarding working, quitting and searching for a job that exist under the current system.

Countries such as Chile have already successfully experimented with innovative unemployment accounts in their public employment insurance system.

A recent study, Incentive Effects of Unemployment Insurance Savings Accounts: Evidence from Chile, published by the United Kingdom’s Centre for Economic Policy Research, found that Chile’s system has increased job-finding rates and reduced unemployment duration. Not surprisingly, workers who rely on individual unemployment accounts search harder for jobs than those not relying on them.

The Conservative government claims the hike in EI premiums is not as much as it could have been. But without offsetting tax decreases and true EI reform, Canadian workers and businesses will face higher taxes for years to come.