Using a Natural Experiment to Estimate the Effects of the Unemployment Insurance Payroll Tax on Layoffs, Employment, and Wages

The experience of Washington State provides a natural setting to examine the effects of the unemployment insurance payroll tax on layoffs, employment, and wages. During the 13-year period from 1972 through 1984, all employers in Washington paid the same unemployment insurance (UI) tax rate. Federal legislation then forced Washington to adopt an experience-rated system in 1985. Thus, a comparison of wages, employment, and layoffs before and after the change has the potential to provide good evidence on both tax incidence and the effects of experience rating. This paper reports our early results from this ³natural experiment.² In our preferred specifications, we find that industry average tax rates are completely passed on to workers in the form of lower earnings. However, our estimates imply that a firm can shift very little of the difference between its tax rate and the industry average rate. Our analysis of layoffs is complicated by business cycle effects. Therefore, our study focuses on seasonal variation in employment. Our estimates are somewhat mixed, but generally supportive of the prediction that experience rating reduces turnover, layoffs, and UI claims.