A few months ago we disclosed that based on its campaign contributions in Q1, Goldman Sachs had turned from Democrat to Republican, as "its campaign spending favored Republicans over Democrats by a margin of 58 percent to 42 percent both for March and the first three months of the year." Furthermore the animosity between the firm and the president is not exactly top secret. So, being the smartest guys in the room, would it not behoove Goldman to endorse precisely those policies which while unlikely to have much economic impact (for the growing futility of Keynesianism see here), are most at odds with prevailing popular opinion of what next steps for the economy should be? We pointed out first two days ago that Goldman is now openly rooting for QE 2.0 and another round of unbridled fiscal stimulus: precisely the kind of behavior that increasingly more people realize is the primary reason why this country is in its current sad place. Today, Goldman economist Alec Phillips continues the shadow attack on the administration, pointing out in excruciating detail what will happen if unemployment benefits are not extended (a topic also discussed previously here), and that some form of passage of the bill is critical, in essence putting the high hurdle strawman before the administration, and boxing it in a lose-lose corner. Regardless of the political sideshow, and we will keep an eye on it, with this week's Initial Claims out due later today, and a likely collapse in Extended Unemployment Compensation and Extended Benefits now that there is, at least for now, no extension, here is how Goldman envisions the over 4 million plunge in those eligible to receive benefits, and the implication of this to the economy.
What Happens If Unemployment Benefits Aren’t Extended?
- Continued inaction on extending unemployment insurance will have resulted in the loss of benefits by over 2 million claimants by the end of this week. While this could slightly reduce reported unemployment, the fundamental effect is clearly negative: it will reduce personal income growth by 0.1% in June and 0.2% in July (if benefits haven't been renewed by then) and add to the fiscal drag we already expect from the expiration of other policies.
- However, despite the widespread perception that extended benefits will be left to expire, there is actually a good chance that Congress will renew them in the end. As we noted last week, historical precedent favors continued renewal through at least the end of this year and probably beyond. Moreover, although there was insufficient support when the issue was brought up last month, the composition of the Senate may soon change, and if not, a compromise on policy still appears possible to gain the incremental support needed.
Last week, we estimated the sensitivity of the US growth outlook to the extension—or lack thereof—of various fiscal policies (see “Stimulus Extension: Becoming More Difficult,” US Daily, June 28, 2010). In our base case, which assumes that unemployment benefits are extended along with health subsidies, some state fiscal aid, and the “Making Work Pay” tax credit, fiscal drag reduces growth by 0.5 to 1.5 percentage points toward the end of 2010 and the first half of 2011. If Congress extended none of these, fiscal policy would constitute a more significant drag on growth of around 2 points, or an average of 1pp relative to our forecast over this period.
The most important fiscal policy question facing Congress at the moment is whether to approve pending legislation to renew the various unemployment insurance-related stimulus measures that Congress enacted in 2008 and 2009:
1. Extended Unemployment Compensation (EUC). The EUC program was enacted in 2008, to provide additional benefits for individuals who are still unemployed after collecting the full 26 weeks of regular state unemployment compensation (UC). This initially consisted of an additional 13 weeks of benefits, known as Tier 1 of EUC. As the recession persisted, Congress enacted Tiers 2, 3, and 4. The result is a maximum of 79 weeks of federal benefits (i.e., 26 weeks of regular benefits plus up to 53 weeks of extended benefits, depending on a state’s unemployment rate). The pending legislation would renew this program for new claims through November.
2. Extended Benefits (EB). Like the EUC program, the EB program provides additional weeks of compensation after other benefits have been exhausted—either 13 or 20 weeks depending on the labor conditions in that state. However, unlike the EUC program, the EB program is permanent, and normally operates on a 50-50 cost sharing arrangement between the federal government and states. For this reason, states have a degree of discretion in whether to provide these benefits, and most large states normally do not. With enactment of the the American Recovery and Reinvestment Act of 2009 (ARRA), the federal government temporarily assumed 100% of this program’s cost. This created an incentive for 27 states to offer these benefits on a temporary basis, to take advantage of federal funding. However, like the EUC program, this provision of law expired at the end of May. temporarily relieves states of their share of this program and assumes 100% of the cost.. Without federal funding, most of these states have opted to drop their EB programs at various points in June. As of May, 80% of the unemployed population in the country resided in these states, by our count. The pending legislation would renew this program through November.
3. Federal Additional Compensation (FAC). This program, enacted in the American Recovery and Reinvestment Act of 2009 (ARRA), provides an extra $25 per week to recipients of regular or extended benefits. Like EUC, it expired at the end of May, but those already receiving it may continue to receive it. Although legislation introduced over the last couple of months would have renewed this program as well, the most recent proposals omit further renewal of FAC due to budgetary constraints.
4. Tax exclusion of unemployment benefits. Normally, unemployment benefits are taxable. ARRA allowed the exclusion of $2,400 of benefits in 2009. However, this provision has also expired, and none of the proposals pending in Congress would extend it.
If Congress fails to extend these policies, the practical effect will be:
1. No more new EUC claims. Individuals who exhausted their regular state unemployment insurance (UI) payment after May 22 will not be eligible for emergency federal benefits at all, i.e. they could receive at most 26 weeks of unemployment benefits.
2. Upcoming benefit exhaustion for those in EUC or EB. Beginning with the week that ends June 12, claimants who have exhausted a given tier of EUC will not be eligible for the next tier; this means that most individuals who were receiving emergency benefits either have already lost benefits or will lose them within the next eight weeks or so. The exhibit below illustrates the progression of claimants through the tiers to date, and the effect of the expiration on total weekly claims (including EUC and EB) in the event that Congress does not renew the law.
3. New benefit amounts will decline by about 8%. Claimants becoming eligible for new benefits as the result of a recent job loss will receive less than those that became jobless earlier as the consequence of the expiration of the $25 bonus payment.
4. A (slight) increase in the fiscal burden on states. Apart from the more significant fiscal consequences of Congress’s apparent decision not to extend the state fiscal aid it authorized last year, a secondary concern for states will be the increased burden on state unemployment programs. As noted above, the most populous states have simply decided to abandon extended benefit programs in the wake of the federal expiration, so this is unlikely to be a significant issue nationally. But for the 12 states that have permanent programs and will now bear half their cost, this could be a concern.
The effects of these expirations have just begun to show up in the data, with more pronounced signs likely over the next few weeks. Among the potential data affected:
1. A (slightly) lower unemployment rate. The direct effect of expiration should be at least a slight decline, for two reasons. First, there may be some unemployed workers who are not actively seeking work but respond as if they are in order to ensure continued benefit payments. If these individuals begin to respond in surveys that they are not actively seeking employment, they would be counted as not in the workforce instead. A portion of the population of EUC and EB beneficiaries may also have delayed accepting employment until a job appropriate to their skills became available. Once benefits end, some of these individuals may find themselves with no choice but to accept less suitable positions. Observing the similar duration of unemployment spells for job losers who are eligible for UI and job quitters who are not, researchers at the San Francisco Fed estimated that extended benefits may have added 0.4 percentage points to the unemployment rate at the end of 2009; the minutes from the January 26-27 meeting note estimates that up to one percentage point of the unemployment rate could be due to extended benefits. If an addition of 0.4 points on the unemployment rate were accurate, for example, this would imply a decline of something like 0.2 points in the rate in June and another 0.2 points decline in July, all other things equal.
2. No effect on initial and continued claims. Initial and continued claims numbers, which reflect activity in the regular UC programs administered by the states, should not be affected by the lapse in extended benefits (EUC and EB continued claims are reported separately, with a lag).
3. A hit to personal income. By the end of June, the Department of Labor estimates 1.35 million claimants will have lost eligibility as a result of the lapse in benefits. By the end of July, this number will have grown to 3.23 million. Assuming an average $300 weekly payment, the lapse will reduce payments by $11 billion (annualized) in June and $39 billion in July, compared with the payments that would have taken place had the policy been extended. This would reduce personal income growth in June by about 0.1 percentage points all other things equal, and by 0.2 percentage point in July.
So will Congress extend these benefits? Our guess is that they will renew EUC and EB, for two reasons. First, the historical precedent argues for an additional extension. As laid out in last Monday’s daily comment, the unemployment rate is higher, has declined by less, and peaked more recently, than at any of the points in the past when benefits were allowed to expire. Second, although some reporting on this issue has presented the end of benefits as a fait accompli, there may be enough support for an extension when Congress returns. The House already passed the measure before Congress went on recess. In the Senate, two Republicans (Sens. Collins and Snowe of Maine) have sided with all but one Democrat (Sen. Nelson of Nebraska) in favor of an extension. This makes 59 votes in the Senate for legislation to extend the EUC and 100% federal EB programs through November. One other Republican (Sen. Voinovich of Ohio) has suggested he could support an extension if half of its cost was offset (this could potentially be accomplished by rescinding stimulus funds scheduled to be spent in 2011 or 2012). Although it is still unclear who will fill the vacant West Virginia (WV) seat in the Senate, this could come within the next week. If the incoming Democratic senator supports extending benefits, as seems likely, this would give Democratic leaders the 60 votes necessary to pass the extension. If not, a compromise would still be possible involving rescinding funds not expected to be spent for another year or two.