Let me start by saying that I’m not advocating to abolish unemployment benefits. And I’m not, at this point, going to try and say how long a person should be allowed to collect them, though I will say emphatically that they cannot be extended indefinitely.
But I flinch every time I read that unemployment benefits “pay for themselves” and every penny goes right back into growing the economy. It makes no intuitive sense to me but I can’t convince anybody simply on my intuition so I’ll turn to my old friends Pat, Chris, and Jamie.
I’ve taken a few economic courses but am no means an expert so I always go back to the first principles I learned in Economics 101 where one person is on an island growing bananas and another person is on a nearby island growing coconuts. Pat, Chris and Jamie are sufficiently gender-neutral names, right?
But I’ll have Pat growing and selling apples and Chris growing and selling daisies. Jamie is just in the scenario as a buyer who always spends the same amount on apples to feed a third island. When things are good, Pat grows enough apples to feed the apple island and to sell to Chris and Jamie. Daisies aren’t really a necessity but make the island a nicer place to live.
As luck would have it, Chris spends the money earned from selling daisies to buy apples from Pat to feed the people on the daisy island.
But then a nasty pest destroys Chris’s daisies and he doesn’t have anything to sell to make money to buy apples to feed the household on his island. The government steps in and taxes Pat to give money to Chris to buy apples. By the logic of the people that say every penny of unemployment benefits goes right back into the economy we must assume that there are no administrative costs associated with the government to collect the money from Pat and give it to Chris. Of course that’s ludicrous but for the sake of simplicity we’ll run with a zero cost government agency here.
So everything flows right back to Pat and everything is fine and he doesn't really need to buy flowers, anyway, right? Sure! As long as Pat’s costs remain exactly the same and no revenues are spent investing in the business.
That can’t happen in the real world, though. What happens when one of Pat’s two apple-picking machine breaks down?
Pat must decide whether to buy a new machine. If Pat buys a new machine the same number of apples will be harvested but profits will be down by the cost of the new machine. Which means Pat will pay less in taxes. That means less money to give to Chris to buy the apples from Pat to feed the daisy island, which means Chris buys fewer apples leading to less profits of Pat’s to tax the next go-round. Of course, the government can step in and raise Pat’s taxes each time to make sure that Chris’s island can buy the same number of apples but that only goes so far.
Because if taxes are raised too far, Pat may not be able to afford to buy the new machine, feed the apple island and still have the same amount of profits to tax without also raising apple prices. So if Pat buys the machine and raises prices so that the government receives the same amount in taxes, it still means that Chris can buy fewer apples than before, which lowers Pat’s profits and the cycle starts again. Without the new machine the apple island will just have to get by producing fewer apples to sell which, again, means fewer profits to tax to give to Chris to buy apples from Pat.
Then what happens if the 2nd machine breaks down and Pat can’t afford to replace it? Now there is nothing of Pat’s to tax and the apple island must depend on the government to feed it, too.
The only way the downward cycle stops is when Chris finds something else to sell.
Those who say that unemployment benefits grow the economy might say that if the government didn’t give Chris the money to buy apples, it would hurt Pat’s business. But if Pat didn’t have to pay the taxes to give to Chris in the first place, it’s a wash for Pat if costs remain the same. If costs increase Pat’s lower tax payment makes funds available to replace equipment or address whatever is driving costs up.
The point isn’t who deserves to receive how much or who deserves to pay how much or how long Chris should be given to find something else to sell or if taxes should help Chris start a new business, etc. The point is that taxing a producer and giving it to a non-producer DOES NOT improve the economy. It actually hampers business growth that would help the economy long-term. It may still be NECESSARY to provide unemployment benefits short-term and temporarily but they must be justified by other reasons, not by an economic fallacy.
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