On August 18, 2011, the Minister of Finance launched another round of public consultations on the Employment Insurance (EI) rate-setting process.  This will be the third time that the Government is proposing changes to the rate-setting process in the last five years. Previous governments were also constantly reviewing the EI premium rate-setting process as well.

This should not be surprising. Simply put, the EI premium rate is a bad tax - probably the worst tax that the government has available to raise revenues. It inhibits employment and economic growth; it is unfair in its impact on low-income workers; it is extremely complex to calculate and administer (http://www.3dpolicy.ca/content/taxing-jobs-raise-revenues-there-has-be-better-way). 

The best option would be to get rid of the EI premium rate altogether and replace it with an alternative source of revenue. One way this could be done is by replacing the lost revenues, about $20 billion, by increasing the GST and corporate income tax rates.  This would address the problem of the working poor by spreading the burden over much larger tax bases.  In addition, the GST low-income tax credit could be increased, sheltering these individuals altogether.  There could be a 50:50 cost sharing during the changeover, thereby removing a long-standing business complaint about the current 1.4 to 1 cost sharing arrangement.

This option would support employment and economic growth; it would eliminate the unfairness of the EI rate, and complexity and misunderstanding would not be an issue. It would acknowledge that the EI account is a “myth” that exists only for the purpose of calculating the EI rate.  

The Government has stated that the objectives of the current consultation process on setting EI premium rates are to:

1.    Ensure the EI program breaks even over time;

2.    Avoid large cumulative surpluses or deficits; and

3.    Maintain transparency in the rate-setting process.

In other words, getting rid of the EI premium rate is not an option this government is willing to consider. This is unfortunate since the tax system, including EI revenues is in urgent need of serious reform and simplification. (http://www.3dpolicy.ca/content/low-tax-plan-definitly-not-good-tax-policy).

The current, as well as previous, EI premium rate setting processes were intended to deal with these objectives. Obviously, they have not. The legislative restriction on annual changes in premium rates has led to the current large cumulative deficits and once these are unraveled (by 2015), they will lead to large cumulative surpluses.  Governments have tried to deal with these issues since the 1980s with little success.  Focusing of these objectives will not resolve the current problems with the EI rate-setting process.

There are four key issues that we feel must be addressed in the current consultation process, all of which are ignored in the stated objectives for the current consultation process.

EI Rate-Setting Process is Pro-cyclical in Nature

The real problem with the EI rate-setting process since the start of the program is that the process is pro-cyclical in nature, because of the requirement to establish a “break-even” rate for the upcoming fiscal year.  This means that during an economic downturn, with increased unemployment and lower employment, the EI rate must be increased, thus acting as a tax on jobs.   During a period of economic growth, with fewer unemployed and more people employed, rates must be lowered.  This is contrary to sound economic management.  Several studies, commissioned by Human Resources and Skills Development Canada[1], have highlighted this problem.  Although these studies were done in the early 1990s, they appear applicable today as there has been little change to the EI rate-setting process since then. Participants in previous consultation reviews of the EI rate-setting process have expressed the same concerns[2].

A cumulative surplus in the EI Account prior to the economic slowdown would dampen the extent of possible rate increases, but only in the short term.  The same holds if there is a cumulative deficit in the EI Account prior to an economic recovery.

The current process attempts to minimize the impact of the pro-cyclical nature of the EI rate-setting mechanism by limiting any change to no more than 10 cents per year (employee rate).  In addition, the Government can override the current mechanism by setting any rate it wants if it considers it to be in the public interest.  However, these measures have an impact on the cumulative balance in the EI Account, which would still need to be addressed over time.

Current EI Rate is a Greater Burden on Working Poor

The second issue is that the burden of EI premiums falls proportionally on the “working poor” - those employees earning below the maximum insurable earnings.  These workers rarely if ever become unemployed and therefore, seldom receive EI benefits.  EI premiums place a larger burden on these workers than those earning above the maximum earning earnings.  As such, it is an inequitable tax on low and middle-income workers.

There is no need for the CEIFB in the Current System

In the 2008 Budget, the Government proposed the establishment of the Canada Employment Insurance Financing Board (CEIFB), a Crown corporation. The stated objectives of the CEIFB are “to 1) enhance the independence of the premium rate setting and 2) to ensure that employment insurance (EI) premiums are used exclusively for the EI program”.  As we have argued earlier, CEIFB does neither. (http://www.3dpolicy.ca/content/time-change-ei-rate-setting-mechanism-again) To date, the CEIFB has made only one recommendation on EI rates, which the Government rejected.  It is fully expected that the Government will set a lower rate for 2012 than recommended by the CEIFB, given the current economic uncertainty.

The CEIFB consists of a seven-member Board, appointed by the Government, based on recommendations of an independent nominating committee.  Public servants are not eligible for consideration.  These Board members may be perceived to be more independent than the previous three-member Commission, as the latter included a government representative.  However, the criteria that must be followed in the setting the employment insurance premium rates leaves virtually no room for discretion in either case.   

Premium rates are currently based on analysis done by the Chief Actuary with the underlying economic assumptions provided by the Minister of Finance.  The Chief Actuary calculates a “break-even” rate for the upcoming year, taking into account, projected benefits and administration costs for the upcoming year as well as past deficits/surpluses in the EI Account.

Under the current legislation, the EI employee premium rate is not allowed to increase/decrease by more than 10 cents per $100 of insurable earnings from any year to the next.  The government, through the Governor in Council, can override the rate recommended by the Board if the government considers it to be in the public interest.  The government froze EI premium rates for 2009 and 2010 and restricted the increase to 5 cents (employee rate) for 2011.  Given the current status of the EI Account, the annual increases in the premium rates will be restricted to increases of 10 cents for at least another 4 years, if not longer.  Clearly, we didn’t need a Crown corporation to tell us this.

The creation of the CEIFB does not ensure that EI premiums are used exclusively for expenses incurred by the EI program.  The EI program continues to be fully consolidated as part of the Government of Canada’s annual financial statements.  Premium revenues continue to be included as part of the federal government’s budgetary revenues and program expenses, both benefits and administration costs, continue to be part of the federal government’s total expenses. As a result, the net financial position of the EI program continues to have a one-to-one impact on the federal government’s budgetary balance.  The creation of a new Crown corporation and a separate bank account did not change that.  The account is be used solely to provide input into the rate-setting exercise – no more, no less – as was done in the past.  The Government still has the legislative authority to set any rate it wants – including a rate higher or lower than the rate recommended by the Board or set in current legislation.

If the Government truly wants to ensure that EI revenues are solely used for EI program costs, it will have to give up absolute control of the program.  For example, it could share responsibility with the provinces for the management of the EI program, as it currently does with the Canada Pension Plan program.  This would ensure that EI revenues and program costs no longer affect the federal government’s budgetary balance.  There would a true separate account, which under the current process is only notional. Changes to the program would require approval by a majority of provinces with majority of the population.  Premium rates would be set over a longer time period – five years - thereby providing stability in the rates.  Past deficits/surpluses would not be taken into account when calculating the rate for the next five years.  The break-even rate over the five-year period would continue to be calculated by the Chief Actuary of the EI program.  The rate proposed would be subject to public consultations and review by outside experts.  The federal government and majority of the provinces would determine the final rate, based on the Chief Actuary’s recommendations and the outcome of the public consultations.  Given the impact that the current EI rate-setting process has on the federal government’s budgetary track to 2015-16, the new rate may need to be phased in.

So why was CEIFB created.  The only reason was to get rid of the cumulative surplus in the so-called EI Account, which as of March 31, 2009 stood at $57.2 billion.  Although purely notional in nature, this balance has been an ongoing embarrassment to the current government as well as previous governments. The creation of the CEIFB effectively wipes out this massive cumulative balance and replaces it with a cash reserve of $2 billion, under the pretense of creating a more independent rate setting process.  In her Opinion on the 2009-10 EI financial statements, the Auditor General noted that one of the measures included in the legislation approved by Parliament in July 2010 amendments to the Employment Insurance Act which “was the closure of the Employment Insurance Account, with a surplus of about $57 billion”.

There was no debate on this when the legislation that created the CEIFB was approved by Parliament. It is doubtful that the current members of the CEIFB and Parliamentarians were even aware of this when they were appointed. There is no rationale for the CEIFB.  The Government misled Canadians in its creation.

The Unnecessary Employer Premium Multiple

Since 1972, employers have paid $1.40 for every $1.00 paid by employees.  This multiple rate was established pending development of an experience rating system, which would vary the ratio based on the employer’s layoff pattern (that condition was dropped in 1977).  The multiple of 1.4 was originally set as a default for all employers until an experience-rating system was implemented.  The rationale for the multiple was that employers have greater control over layoff decisions and therefore should pay a higher share of overall EI program costs.  This puts an additional burden on small business, in much the same way, as the limit on maximum insurable earnings puts on low- and middle-income workers.  In addition, since 1972, the EI program has been significantly enhanced through the introduction of new programs (parental leave, compassionate leave, etc), which have no relation to layoffs. 

Recommendations

Recommendation 1: Serious consideration should be given to getting rid of the EI premium rate altogether, either on its own, or as part of a broader review process on simplifying and reforming the tax system. Tinkering with the current system will not eliminate the inequities and inefficiencies of the current system.

 Recommendation 2: The CEIFB should be disbanded.  It has no real role in the setting of EI premium rates, given the current legislation. It has no option but to recommend annual changes of no more 10 cents. Whatever it does recommend, the Government still has the option of overriding it.  It has no real voice. It is a façade.

Recommendation 3: The pro-cyclical nature of the current EI rate should be eliminated. Recommendation one would achieve this goal. Alternatively, if the current system is maintained, premium rates could be set over a longer (e.g., five years) period, providing stability in rates and ensuring that over this longer period, EI premiums are counter-cyclical and not pro-cyclical.  The Chief Actuary would calculate the EI rate over the longer period. . The House of Commons Standing Committee on Finance would hold public consultations.  The Minister of Finance would make the final decision.  Past cumulative surpluses/deficits would not be taken into consideration in calculating the rate going forward.  Given the impact that the current EI rate-setting process has on the federal government’s budgetary track to 2015-16, the new rate may need to be phased in.

Recommendation 4: The government should not give up control of the EI rate setting process. Under Recommendations one and three the government would maintain control. On the other hand, If the Government truly wants to ensure an independent rate seeing process, and ensure that EI revenues are solely used for EI program costs, then this would require setting up a true fund outside the control of the government and Consolidated Revenue Fund. This would seriously weaken the government’s capacity to fulfill its responsibility for overall economic management.

Recommendation 5: The Government should base premium costs to companies based on experience rating.  Rates would be higher for those companies that are more cyclically sensitive and/or more seasonal in nature. 

Experience rating has been discussed and debated many times in the past, with no resolution.  It is doubted that it will be any more successful this time around.  However, the Government could provide a tax credit to the working poor and their employer, based on their previous experience with the program.   

[1] “The UI System as an Automatic Stabilizer in Canada”: by Peter Dungan and Steve Murphy: “Canada’s Unemployment Insurance Program as an Economic Stabilizer” by Ernie Stokes WEFA Canada

[2] See Department of Finance: Employment Insurance Premium Rating-Setting Mechanism Consultations: Summaries of Consultations Prepared by the Department of Finance