03/06/2013 05:21 EST | Updated 03/06/2013 05:23 EST

Why the EI Program Should Become a True Insurance System

The recent changes to the employment insurance (EI) system implemented by the Conservative government continue to fuel discontent in the eastern provinces of Canada. Under the new rules, frequent users of EI are now forced to accept -- in the worst-case scenario -- a job that pays 70 per cent of the previous wage and which is located at a one-hour commute from home. The government is hoping to break the vicious circle of dependency among workers whose occupation makes them rely on employment insurance benefits on a recurring basis.

In its previous form, one could hardly deny that the program offered little incentives to seek work throughout the year. For instance, a recent study revealed that only one out of four seasonal workers in Quebec is looking for year-round employment.

Several empirical studies have examined the effects of EI on incentives to work. One study in particular sought to measure the extent to which the generosity of the employment insurance program in Canada, compared to that of the US, has helped to maintain a "seasonal way of life" among certain categories of workers.

By comparing the respective situations of New Brunswick and Maine, two adjacent jurisdictions with a similar economic structure, the authors found results that should come as no surprise to anyone. New Brunswick's workers were 5 to 10 times more likely to receive some EI benefits than workers in Maine at the beginning of the 1990s. Thanks to the greater generosity of the program this side of the border, the EI expenditures in New Brunswick, as a percentage of GDP, were about 6 times as large as in Maine.

In any case, even if the new reform were to improve incentives to work, it does nothing to address more fundamental problems with the EI program. In fact, the employment insurance system in Canada, despite its name, is much more akin to a transfer program than a true insurance program.

Indeed, the system in its current form contradicts one of the basic principles of insurance: those who represent the highest risk should pay higher premiums. This is what we observe in all private insurance markets. For example, auto insurance premiums for young drivers, especially males, are generally higher (given their higher risk of having an automobile accident) than those of more experienced drivers with a good driving record.

However, the employment insurance program is financed by payroll taxes (paid by employers and employees), the rates of which are the same for all regardless of the industries or occupations. As certain sectors and types of jobs have higher (lower) risk of unemployment, it would therefore be logical if the contribution rates varied according to the higher (lower) probability that these workers resort to EI one day.

For all practical purposes, the EI provides an implicit wage subsidy for industries that employ workers with a high risk of unemployment. If there were no EI, construction workers, for instance, would ask for higher wages in order to be compensated for the higher risk of being out of work at some point in time in any given year. Currently, companies in the construction sector can pay relatively lower wages knowing that the EI act as a cushion should there be layoffs. In addition, workers require a lower wage compensation for the risk of unemployment because their income will not decline as much in times of unemployment, thanks to the EI program.

The EI program should serve to provide temporary financial support for workers who involuntarily lose their job. It was designed neither to provide extra income to certain categories of workers who do not want to hold a job all year long, nor to subsidize some industries or occupations. The program must be reformed so as to become a true insurance program that does not impede incentives to work.