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Government: Paying for unemployment

October 31, 2011 |  1:04 pm

Unemployment Trust Fund Reserves
It's hard to believe, but California is actually a low-tax state in one important respect: the taxes employers pay for unemployment insurance.

According to a new report by the Tax Foundation, California is tied with two other states for the lowest unemployment insurance taxable wage base in the country. It assess taxes only on the first $7,000 in wages per worker; most states have a taxable base of $12,000 to $37,300.

California also has a lower tax rate than most states, maxing out at 6.2%. Combine the low tax rate with the low wage base and it's a wonder that jobs are moving from here to Texas instead of the other way around. (Note to readers: I'm kidding! No need to post comments cataloging the many advantages of setting up shop in the Lone Star State.)

The report's statistics suggest that the average hourly cost of unemployment insurance to employers is even less than the national average of 21 cents, or less than 0.7% of labor costs. But as the state has been learning the hard way, the amount of revenue raised isn't nearly enough to cover the cost of providing unemployment benefits during a steep recession. That's true despite the state's below-average benefits; citing figures from the U.S. Department of Labor, the Tax Foundation reported that California's average weekly benefit is just below the national average, which is $296.

By the foundation's calculations, California had only enough insurance funds to cover about three months  worth of unemployment benefits during a severe downturn when the recession hit in the first quarter of 2008.

It wasn't alone -- 17 other states didn't have enough in reserve to cover a full 26 weeks of benefits in the event of a spike in unemployment. All told, 34 states have borrowed from the federal government to pay their share of unemployment benefits, and they collectively owe Washington more than $37 billion. California alone owes almost a fourth of that sum.

The tab for that borrowing is now coming due. The federal government is dunning states for about $1.3 billion in interest on their unemployment insurance debts in the current fiscal year. California has paid its share: $304 million, or about half the amount cut from the University of California's budget. But wait, there's more: Next month, Washington is expected to impose higher taxes on employers in about two dozen states, including California, that haven't paid down their federal UI loans. That tax increase, although small, will be retroactive to Jan. 1. Ouch.

We can debate how much an annual tax increase of no more than $21 per worker will matter to employers, who will certainly look for ways to pass those costs along to their employees (as they do all unemployment insurance expenses). But it's clear from the report that states have done a poor job insuring themselves against big downturns because they're incapable of building up large enough reserves in their unemployment trust funds.

As the graph at the top of this post shows, state unemployment trust fund reserves have declined sharply over the last six decades. During the relatively good times between 1995 and 2005, "31 states reduced UI taxes by at least 20%," the report states. The reductions reflect the fear in some quarters that large reserves would encourage lawmakers to raise benefits, leaving the trust fund vulnerable to shortfall in a big downturn. Nevertheless, cutting taxes achieved the same result. As the foundation put it:

Whether unemployment insurance benefits create net jobs or not, the claim that UI is effective countercyclical policy is belied by the prevalence of UI tax reductions in good economic times and UI tax increases, benefit cuts, and borrowing in bad economic times. All told, 35 states raised UI taxes in 2010 by increasing either the tax rate or the taxable wage base while fiscal pressures are leading many states to cut benefits. In years leading up to the recession, by contrast, many states reduced UI taxes and did not accumulate reserves during times of low unemployment.

Actually, the fact that states didn't build up enough reserves doesn't negate the countercyclical effect of unemployment insurance. Far more (borrowed) money has been pumped into the economy than has been pulled out in the form of higher taxes. But the foundation's skepticism about the ability of states to create reserves for a rainy day is warranted. The temptation to reduce taxes in good times is overwhelming, even if it raises the likelihood of having to raise them in bad times.


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-- Jon Healey

Credit: Tax Foundation

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