Unemployment Insurance: Strengthening the Relationship between Theory and

E ver since the U.S. federal–state system of unemployment insurance wasfounded in the 1930s, it has provided partial, temporary replacement ofwages to eligible workers who lose jobs “through no fault of their own ” (as determined by state-level regulations). Unemployment insurance is one of the largest social insurance programs in the United States, with benefits paid totaling about $34 billion in 2004. This figure is considerably smaller than for Social Security, Medicare or Medicaid, but it exceeds spending on such major programs as Workers ’ Compensation, Temporary Assistance to Needy Families (TANF) or Food Stamps. In this paper we focus on the ways economic theory can help us understand the challenges that this complex program is likely to face over the next few years. We begin by summarizing the salient characteristics of the unemployment insurance program and then examine the theoretical and econometric research. Much of this research revolves around the main goals of the program, which include: 1) sustain-ing consumption for workers and their families; 2) helping recipients to make efficient job choices during a period of financial stress; and 3) minimizing the adverse incentives that may accompany partial wage replacement. Of course, these goals can come into conflict—for example, if replacing wages for an unemployed worker also discourages that worker from aggressively searching for or accepting a new job—and our discussion will focus on these conflicts. With this background, we then conclude with a discussion of the key policy issues that the unemployment insurance system is likely to face in upcoming years and a description of ways i