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From unemployed to self-employed: New law ignores moral hazard

By   /   Friday, March 9th, 2012  /   2 Comments

If Uncle Sam would pay you to become unemployed for six months and then create a small business, wouldn’t you want to become an entrepreneur?

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By Steve Mintz on March 9, 2012

If Uncle Sam would pay you to become unemployed for six months and then create a small business, wouldn’t you want to become an entrepreneur?

On Feb. 22, President Obama signed into law the Middle Class Tax Relief and Job Creation Act of 2012, a bill that is estimated to cost $150 billion.

Most people are familiar with the payroll tax cut extension provision through year’s end that lowers the workers’ payroll tax obligation from 6.2 percent to 4.2 percent. Many know about the change in requirements in the unemployment benefits program, including weaning some of the 3.5 million current recipients off federal jobless benefits. It would eventually cap the maximum duration of benefits at 73 weeks, instead of 99, depending on a state’s jobless rate. Americans out of work the longest and in the hardest-hit states would be shielded from most of the cuts. What few Americans know, however, is the bill provides unemployment benefits for self-employed workers.

The Startup Technical Assistance for Reemployment Training and Unemployment Prevention, or STARTUP, Act alters the rules governing the unemployment insurance program to allow recipients starting their own small businesses to collect their unemployment without the added burden of searching for other full-time work.

Current unemployment insurance rules require recipients to be actively searching for and willing to accept suitable work. Self-Employment Assistance, or SEA, allows a small number of those same recipients who want to start their own businesses to maintain their benefits while they build their companies. Allowing entrepreneurs the ability to focus on building their businesses instead of looking for other work just to keep their unemployment benefits increases their likelihood of success. Would-be entrepreneurs must have a valid business plan to receive SEA, but will also be eligible for job training opportunities to further increase that likelihood of success.

The law allows for a one-year program totaling $35 million which is both authorized and appropriated, guaranteeing that the funding will be used to foster small-business growth. Several states, like Oregon and Delaware, already offer similar programs to qualified unemployed. The provision in the payroll tax and unemployment insurance extension agreement would expand that opportunity to promising entrepreneurs nationwide.

The economic rationales for the self-employed assistance program include: (1) It will get some unemployed off the public dole; (2) It helps to foster a spirit of entrepreneurship; and (3) It will assist small businesses to hire Americans thereby reducing the number of unemployed. This rationale relies on the long-believed notion that small businesses are the creators of new jobs and engines of future economic growth.

I agree with the rationale but question what happens in the real world and whether the cost of yet another level of bureaucracy creates more costs than benefits to society. How will it be determined that an unemployed, would-be self-employed individual is eligible for the expanded benefits program? The notion that “would-be entrepreneurs must have a valid business plan to receive SEA … and be eligible for job training opportunities to further increase that likelihood of success” is problematic. What is a valid business plan? It would seem that states would need to hire additional, better-trained workers to assess the skills of SEA beneficiaries.

How will it be determined that the beneficiary is serious about starting a small business? As previously mentioned, the bill incentivizes every state to offer the program, providing technical assistance from the Labor Department and authorizing $35 million in state grants over the next three years to establish, implement, improve and administer the programs. Do we really want an additional state bureaucracy on top of the federal layer at a time when state and federal deficits are spiraling out of control?

There are many ethical issues to consider. First and foremost is: Do the added costs of administering and monitoring the new program exceed the benefits to society of providing unemployment assistance to the unemployed, self-employed wannabes? This is similar to many issues we face with respect to trying to be a compassionate society while recognizing our moral obligation to future generations to not provide them with a bankrupt country.

To carve out a new group of unemployment insurance recipients, no matter how well intended, opens the door for other exceptions that can create an ethical slippery slope. Moreover, moral hazard risks exist because there may be a tendency to look to become unemployed in order to use the 26 weeks to create one’s own business. In this way the provision may unknowingly lead to questionable behavior that raises doubts about a person’s work commitment and increases the emphasis on the pursuit of one’s self-interest without regard to the possible costs to society.

• Steve Mintz is a professor of accounting in the Orfalea College of Business at Cal Poly San Luis Obispo. He blogs about business issues at www.ethicssage.com and www.workplaceethicsadvice.com.

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2 Comments

  1. Martin says:

    In order to receive unemployment benefits after losing a job, you are required to demonstrate that you are actively looking for full time employment and are available to take it. This law makes it possible for an unemployed individual to pursue self-employment without having to look for other work concurrently. Failure to meet this requirement of unemployment benefits is fraud.
    Allowing entrepreneurship as an alternative path to employment is like teaching a man to fish instead of giving him a fish every two weeks, and success would encourage further employment of others.

  2. Rosanne says:

    Your views on not supporting unemployment insurance for the self-employed are controversial but thought-provoking.

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