UNEMPLOYMENT BENEFITS WITH A FOCUS ON MAKING WORK PAY

EUROPEAN SEMESTER THEMATIC FICHE UNEMPLOYMENT BENEFITS WITH A FOCUS ON MAKING WORK PAY Thematic fiches are supporting background documents prepared by the services of the Commission in the context of the European Semester of economic policy coordination. They do not necessarily represent the official position of the Institution. 1. Introduction Unemployment benefits are a key feature of all European welfare systems. By insuring workers against the risk of job loss, they provide an essential safety net for individuals and households. They also play a stabilising role over the business cycle in supporting incomes of the unemployed who tend to be low income. In addition, unemployment benefits allow for a smoother relocation of labour across the economy, as job-seekers can devote more time to finding a job that matches their skills and expectations, thereby preserving their employability. At the same time, however, a high level of benefits can reduce the incentives to return into employment, with negative effects on unemployment duration and total unemployment, and impact on social protection systems. By providing income replacement and reducing the gap between labour and non-labour income, unconditional unemployment benefits might reduce incentives to search and take up jobs, which can have a detrimental impact on employment. Unemployment benefit systems vary widely across Member States, and operate within a broader context given by the existing economic and institutional framework. The entitlement conditions for receiving unemployment benefits, their duration and time profile, their monetary level and the way in which they are calculated can differ greatly. For example, the duration of unemployment benefits can range from 90 days to indefinite duration, while their amount can be determined as a percentage of the last wage, or as a flat rate (namely, a fixed amount), or as the result of a formula comprising both these elements, with the possible application of minimum and maximum thresholds. Furthermore, incentives to work are influenced not only by the unemployment benefit system, but also by the tax and benefit system in general and in particular by the combination of other (usually) means-tested benefits such as social assistance, housing benefits, family benefits and in-work benefits. Likewise, individual job-search effort and availability are influenced by the provision of active labour market policies as well as by the overall economic and labour market conditions. 1

Unemployment benefits can take the form of either unemployment insurance or unemployment assistance. Unemployment insurance benefits are characterised by a clear contributory logic. Therefore, they can only be claimed after a certain minimum period in employment with paid contributions, their level is often established in proportion to level of earnings received in the previous job and their duration often depends on the length of the contribution record. Unemployment assistance is primarily aimed at preventing unemployment-related poverty: it is normally means-tested and made available to unemployed individuals who are ineligible or no longer entitled to unemployment insurance benefits. The level of unemployment assistance benefits is generally lower than the one of unemployment insurance. The majority of Member States do not have a separate unemployment assistance scheme in place, but mostly rely on general means-tested social assistance made available to low-income households. 1 2. Identification of challenges The design of unemployment benefit systems needs to strike a balance between the objective of sustaining households' incomes and the need to adequately preserve work incentives. Benefits vary both in their level (in particular relative to previous earnings), and in their duration over time. The level of benefits ought to be sufficiently high to ensure adequate standards of living for the unemployed, while their duration should give unemployed individuals enough time to find a suitable job that matches their skills. On the other hand, it is important that the gap between the level of income provided by unemployment benefits and the income potentially earned from employment is sufficiently large to make the return to work sufficiently financially attractive. In addition it is important that specific features of the unemployment benefit system provide additional support by "activating" unemployed individuals, without affecting directly the level of benefits. These include job-search and availability requirements, compulsory participation in active labour market programmes, and the imposition of sanctions such as the suspension of benefit eligibility in case of non-compliance. 3. Identification of policy levers to address the challenges Different dimensions of unemployment benefit systems can be compared across countries on the basis of various indicators. 2 These include the duration of benefits, 1 2 Some Member States (Austria, Germany, Estonia, Finland, France, Ireland, Malta, Portugal, Spain, Sweden and UK) have a separate means tested unemployment assistance benefit. The main source of these indicators is the joint European Commission-OECD Tax and Benefit project, based on the OECD Tax and Benefits models. For more information, see: http://ec.europa.eu/social/main.jsp?catid=1143&intpageid=3197&langid=en). 2

entitlement conditions, financial disincentives measured by unemployment and inactivity traps and net increase in disposable income, time profile of net replacement rates and job search and availability requirements. Depending on the dimension analysed, the indicators refer to the characteristics of the most appropriate income support instrument (unemployment insurance to measure the risk of unemployment traps at the beginning of the unemployment spell, social assistance to track the risk of inactivity traps, both unemployment insurance and unemployment assistance to measure the extent to which benefit generosity decreases over time and the related risk of benefit dependence). The indicators are presented in Table 1, Figure 1, Figure 2 and Figure 3 below. Duration of unemployment insurance benefits: benefit duration can be a source of benefit dependency if it is overly long, which is more often a risk for workers with a long contribution period and older workers. The indicator presented in Table 1 is constructed with reference to the standard case of an unemployed individual who has 40 years of age and has 22 years of contributions. Figure 1 shows instead the minimum and maximum durations possible for individuals qualifying for unemployment insurance. Entitlement conditions: Entitlement to unemployment (insurance) benefits generally depends on the previous contribution record. The duration of contributions required in order to be entitled to unemployment benefits varies greatly across Member States, as well as the exact rules under which it is defined. In practice, eligibility conditions are specified either as the requirement of having a certain contribution record measured over the entire work career (e.g. having worked and paid contributions for at least 2 years), or as the requirement of having paid a certain number of contributions over a given reference period (e.g. having at least 12 months of contributions paid in the 24 months preceding unemployment). Together with duration, entitlement conditions affect the coverage of unemployment benefits: the stricter the entitlement conditions, the smaller the share of unemployed covered by unemployment benefits. Net replacement rates: they express the net income received by unemployment benefit recipients as a proportion of the net income that was earned before becoming unemployed. Net income is defined as income after taxes and social security contributions, with the inclusion of possible social benefits (social assistance, family, housing and in-work benefits). Their level and profile over time provides a clear indication of the adequacy of the system, accounting explicitly for the tax system and the provision of other welfare benefits. The profile of net replacement rates over 60 months is shown in Figure 3. It corresponds to the standard case of an individual aged 40, after 22 years of contributions, with earnings amounting to 67% of the average full-time level (it should be stressed that the profile of net replacement rates can differ substantially depending on the contributions history, in particular for shorter contribution records). A detailed description of the legislation used for the computation of most parameters can be found in the OECD Tax and benefits country chapters, published on the OECD's website: http://www.oecd.org/els/soc/benefitsandwagescountryspecificinformation.htm. The indicators of entitlement conditions and job-search and availability requirements have been constructed by Venn, D. (2012) "Eligibility Criteria for Unemployment Benefits", OECD Social, Employment and Migration Working Papers, No. 131. http://dx.doi.org/10.1787/5k9h43kgkvr4-en, and replicated by Langenbucher, K. (2015) "Eligibility Criteria for Unemployment Benefits", OECD, forthcoming. 3

Availability requirements and suitable work criteria: this indicator describes the existence of requirements for benefit recipients to remain available for work while taking part in active labour market policies (ALMPs), and the type of job offers that jobseekers have to take up. It considers how much a benefit recipient is expected to remain available and actively search for a new job while participating in training or work experience programmes (or other ALMPs). It encompasses also the extent to which benefit recipients can refuse a job offer without incurring into sanctions (e.g. in cases involving a change in occupational area, a lower salary in comparison to the former occupation, or requiring geographical mobility). The indicator is a composite index ranging from 1 (least strict) to 5 (strictest). Job search and monitoring: this relates to the monitoring of job-search activities undertaken by the benefit recipient. In particular, how often the unemployed have to prove that they have been independently looking for work, and the formal requirements that benefit recipients have to fulfil concerning their job search activities. The indicator is a composite index ranging from 1 (least strict) to 5 (strictest). Sanctions: this indicator provides a synthetic measure of the strictness of sanctions that may be imposed on jobseekers in cases such as voluntary unemployment, refusal of a "suitable" job offer, or failure to participate in ALMPs. The sanctions themselves are generally defined in terms of reduction, suspension or termination of the (remaining) unemployment benefits. For example, in most Member States voluntary unemployed (workers who have voluntarily quit their job) are not eligible for unemployment benefits, or have to undergo a long waiting period before claiming them. The indicator is a composite index ranging from 1 (least strict no sanctions) to 5 (strictest highest sanctions). Unemployment traps: they provide a measure of financial (dis-)incentives to take up work for individuals benefiting from unemployment insurance (measured at the beginning of the unemployment spell). Unemployment traps are often very high for low wage earners and workers accepting job offers with lower re-employment wages. The indicator measures the marginal effective tax rate on labour, namely the extent to which the increase in gross earnings when moving from unemployment to work is reduced as a result of income taxes, social security contributions and the withdrawal of benefits. It usually ranges between 0 and 100; high values correspond to low incentives to take up work. Inactivity traps are defined similarly to the unemployment trap indicator, but measure the (dis-)incentives to take up work for individuals who are not receiving unemployment benefits (either because not entitled or no longer eligible), but potentially benefiting from social assistance and other out-of-work means tested benefits, if available. Net increase in disposable income: like the unemployment trap, it provides a measure of financial (dis-)incentives to take up work for individuals receiving unemployment insurance benefits, but rather than measuring the share of gross income that is taxed away, it gives the net gain (in terms of disposable income) for the unemployed when moving into employment. 4

4. Cross-examination of policy state of play Looking at all these relevant dimensions allows to better gauge how unemployment benefit systems perform in terms of their objective of providing income support and stabilisation while preserving incentives to take up work. In addition, it helps having a more thorough assessment of each objective. For instance, looking only at unemployment traps (which take into account replacement rates at the beginning of the unemployment spell) and the duration of unemployment insurance benefits may be misleading, as it does not permit to capture the implication on incentives associated with the structure of benefits over time and job search conditionality. Furthermore, one needs to reflect on activation support, including not only with respect to the range of requirements to maintain the receipt of unemployment benefits, but also with respect to minimal support services, in particular early intervention for jobseekers recently registered with an employment service and intensified counselling, education and training or another active measure (ALMP) in the first months of the unemployment spell. Table 1: Selected dimensions of unemployment benefit systems * Unemployment insurance in Belgium is of indefinite duration. Notes: Data are presented for the most recent available years. Unemployment, inactivity trap and net increase in disposable income are averages over four different stylised family types (single person with and without children, one-earner couple with and without children) and two earnings levels (67% and 100% of average full-time earnings). Unemployment benefit duration is expressed in months, and refers to the case of a worker with 40 years of age and 22 years of contributions. The indicators "availability conditions", "job-search conditions" and "sanctions" are expressed as an index ranging from 1 (least strict) to 5 (strictest). The indicators "unemployment trap" and "inactivity trap" are expressed as percentage points of additional gross earnings when moving to employment. Net increase in disposable income is expressed as a percentage of net income when unemployed. Sources: European commission based on OECD Tax-Benefits models; Langenbucher, K. (2015) "Eligibility Criteria for Unemployment Benefits", OECD, forthcoming. 5

The evaluation of reform needs in individual countries can be supported by, among others, cross-country comparisons of policies and institutions in countries facing similar situations and challenges, as they highlight areas where specific countries lag behind. Unemployment benefit duration varies greatly among Member States and depends also on past work records. For instance for a worker with a long work history (22 years of contributions) it ranges from 3 months in Hungary or 5 months in the Czech Republic to up to 24 months in Denmark, France and Portugal (see table 1). Considering shorter work histories would translate into shorter durations in many Member States since the maximum duration generally increases with tenure (see figure 1). Figure 1: Duration of unemployment insurance benefits, 2013 Notes: Duration measured in months. Lower bound refers to the benefit duration which normally applies for those unemployed who just qualify for unemployment benefits, i.e. eligible unemployed with the shortest contribution period. Upper bound refers to the maximum benefit duration which normally applies for those unemployed who have the longest contribution period. In Belgium the duration is indefinite. In Denmark, Finland and Latvia the minimum and the maximum duration coincide.source: European Commission, based on OECD Tax-Benefits models. The duration of contributions required in order to be entitled to unemployment benefits (the qualifying period) also varies greatly across Member States, as well as the rules under which they are defined. It should be noted that national rules rely on different definitions and methods of measurement of the duration of the required contribution period. 3 In 2015, the 3 In some countries contribution period is calculated based on hours (e.g. in Denmark 1 924 hours corresponding to one year of full-time work is required), in some other countries work is measured according to daily, weekly or monthly record, while yet in some others they are combined (e.g. in Sweden 6 months and at least 80 hours of work per months is required). In addition, rules vary in what is considered as work, e.g. in Czech Republic qualifying period of 12 months can be completed by substitute periods of employment such as 6

minimum contribution period ranges between 3 months in Croatia and Italy (after a recent reform in May 2015) and 2 years in Slovakia (figure 2). Figure 2: Entitlement conditions - minimum contribution requirements, 2015 Notes: The ratio of minimum contributions over the reference period (right-hand axis) shows the proportion between the duration of contributions required, and the maximum period over which these are considered. For Cyprus there is no fixed period: 6 months of contributions are required since the last unemployment spell. In Belgium, the minimum duration of contributions required to become entitled to unemployment benefits varies with age (the result above is shown for workers who are less than 36 years old). Source: European Commission, based on MISSOC, OECD and national sources. Furthermore there are important differences as regards the reference period during which the contribution must be made, which also affects the strictness of eligibility conditions (see figure 2, on the right-hand axis estimates of the length of the contribution period as a percentage of this reference period). The lower the percentage, the longer is the reference period in relation to the contribution period, therefore making it easier for the unemployed to be entitled (in Cyprus, there is no reference period). However, due to the diversity of policies in place, the monitoring of such criteria can be of a more qualitative nature. 4 Finally there are differences as regards the level of replacement rates and their composition (unemployment insurance, unemployment assistance and general social assistance) and personal care of a child. On the other hand, e.g. in Malta the number of paid sickness days prior to unemployment is deducted from the benefit duration entitlement. 4 For example, in MT, one needs to fulfil a contribution period of 50 weeks of which at least 20 weeks during the past two years (in the chart, % of reference period refers to 50 weeks out of two years, which reflects the distinction between contributions over the whole career and over the latest working period). In IE, 26 weekly contributions need to be paid in each of the two tax years preceding the benefit year (it is also possible to qualify with 9 months out of 12 with previous work experience). In IT, a total of 13 weeks of work is needed in the reference period of 4 years, of this 30 days of work must be accrued during the one year prior to the onset of unemployment. In SK, the reference period is 4 years for those in temporary employment (in the chart, the reference period of 3 years, reflecting other situations, is used). In the UK, there is no qualifying period, but the entitlement is based on paid contributions in the last two tax years. 7

their profile over time, with in general declines in replacement rates levels over time (figure 3). In addition replacement rates are generally higher the lower former wages and may decline for shorter work histories, which can make access to unemployment insurance benefits more difficult (the figure provides information for the case of a worker with 40 years of age and 22 years of contributions, at 67% of the average wage). Figure 3: Net replacement rates of unemployment benefits over time, 2013 Notes: Replacement rates are expressed as a percentage of previous net income from work. Earnings level is set at 67% of average full-time earnings. Time duration spans from 1 to 60 months of unemployment. Chart absent for Cyprus because of missing data. Source: European commission, based on OECD Tax-Benefits models. Date: 26.11.2015 8