The economic fallout from COVID-19 continues to exact a toll on America’s patchwork unemployment insurance (UI) system. State trust funds, which normally finance benefits, have been strained by an unprecedented swell of claims. According to new data from the Department of Labor, the trust funds of 40 U.S. states and territories have resources below the minimum solvency standards recommended by the federal government. Meanwhile, unemployed workers continue to face difficulties accessing benefits, a result of administrative problems stemming from heightened demand and historic underfunding.
In order to shore up trust fund resources, states are borrowing from the federal government. As of January 1, 2021, 18 states have a total of $45.5 billion in outstanding loans. When these loans come due, it could dampen the economic recovery by imposing additional federal tax increases on employers. (It is worth noting that many of these employers will already face higher state taxes this year, a result of “experience rating,” which ties a business’s UI payroll tax rate to the number of workers accessing benefits.)
Policymakers could address this challenge by linking trust fund relief to administrative improvements, which would help avoid tax hikes while simultaneously enhancing benefit delivery.
As we detailed in a previous blog, the UI system is a federal-state partnership. Under normal circumstances, states are primarily responsible for the cost of benefits, which are financed by state payroll taxes on employers. (The federal government has taken on the cost of the expansions and benefit supplements enacted in response to COVID-19.) These state resources are held by the U.S. Treasury Department in individual trust funds for each state. The federal government also applies a UI payroll tax on employers, which is used to fund the administrative costs for UI.
States can borrow from the U.S. Treasury Department to finance benefits if their trust funds come under pressure. States that are unable to repay their debt in full within roughly a two-year time period enter what is known as a “credit reduction state.” When this occurs, employers in the state lose eligibility for a tax credit on their federal UI payroll tax, causing their effective tax rate to sharply increase from 0.6% to 6% on the first $7,000 of wages. The additional revenues are then used to pay down the debt states owe to the federal government.
This system provides an important cushion for states, allowing a self-financed way for unemployed workers to continue accessing benefits regardless of the solvency of a state’s trust fund. Unfortunately, however, given the potential long-term economic ramifications of COVID-19, employers could very well face these tax increases before the economy reaches full employment. New research suggests that this could lead to reductions in hiring, potentially hampering the economic recovery.
Meanwhile, unemployed workers continue to face delays in accessing UI benefits due to antiquated infrastructure and increased claims. In February, just six states reported meeting the federal standard of providing benefits to 87% of applicants within three weeks.
Additionally, the system suffers from significant fraud. The Department of Labor identified more than $5 billion in fraudulent payments from March to October 2020—mostly via suspicious email accounts and multi-state claimants—and the total amount is much higher. California alone has reported paying out $11 billon in fraudulent claims since the onset of the pandemic, equivalent to 10% of its total benefits paid, and estimates suggest the figure could be as high as $29 billion.
Federal policymakers have an opportunity to address these financing and operational shortcomings simultaneously. This could be achieved by providing financial support for state UI programs in tandem with a set of performance metrics designed to improve benefit delivery and reduce improper payments.
For example, Congress could allocate funding to improve state UI administrative systems that would allow states to use any leftover resources to shore up UI trust funds after they have met new performance standards. Alternatively, the federal UI payroll tax credit could temporarily be tied to administrative improvements. Under this approach, states would be allowed to delay entering the “credit reduction state” if they meet administrative performance benchmarks. This would provide states with more time to repay their trust fund loans and would postpone the tax increase on employers. Whatever course lawmakers choose, it is imperative that they prioritize improving benefit delivery, which will help displaced workers, reduce fraudulent payments, and support the economic recovery.
State UI programs are facing pressure from all sides. Antiquated administrative systems are leading to consistent delays in benefits, and trust fund resources are drying up, causing states to borrow from the federal government. Raising UI taxes on employers to pay back borrowed funds could inhibit the economic recovery. As lawmakers continue to grapple with the long-term economic effects of COVID-19, they should think creatively on policy approaches that link the twin challenges of shoring up the UI trust funds and improving administration.
Cameron Baird contributed to this blog.