The COVID-19 pandemic and subsequent economic collapse have put pressure on state unemployment insurance (UI) systems, many of which do not have adequate reserves to finance an unprecedented increase in benefit claims. Although some state funds are at risk of being depleted, there is little reason to fear that states will be unable to finance benefits in the near future. This is because UI allows states to borrow from the federal government and then automatically adjusts payroll taxes on employers to pay back the debt. A bigger challenge is states’ inability to administer benefits effectively, a problem that must be addressed in order to protect vulnerable Americans from the continued economic fallout of the coronavirus as well as future economic downturns.
UI operates as a federal-state partnership, providing temporary cash support to unemployed workers and thereby mitigating the impact of recessions. The program is financed through separate federal and state payroll taxes collected on employers. These revenues are held in trust funds by the U.S. Treasury Department.
Each state administers its own system and is responsible for the majority of the costs. States have broad discretion over the tax regimes that finance their respective programs, the design of their program benefits, and the computer systems that run them; they are also not subject to trust fund reserve requirements. This flexibility leads to major differences across states in terms of the generosity of benefits offered, the efficiency of benefit delivery, and the extent to which trust funds have adequate resources to pay out benefits during a recession. The onset of COVID-19 has illuminated these stark differences, as some states struggle to administer benefits effectively, and others are seeing a depletion of their trust fund resources.
Prior to the pandemic, 22 states and jurisdictions were flagged by the Department of Labor for having insufficient trust fund reserves to support UI claims during a recession. Now that we may be in the midst of the greatest economic downturn since the Great Depression, many of these states (and potentially more) will require a loan to continue paying benefits.
States can borrow from the federal government to shore up their trust funds and repay their debt over an extended time period. Alternatively, states can borrow from the private market. Interest accrues daily on the federal loans, and the Treasury Department applies any excess payroll taxes collected by states to this debt. If a given state still owes money to the federal government after roughly two years, the state moves into what is called a “credit reduction state,” which leads to an increase in the effective federal payroll tax rate on employers, generating additional revenue to pay down the state’s debt.
Specifically, the federal government finances its portion of the UI system through a 6% payroll tax on employers on the first $7,000 of each worker’s wages. Under normal circumstances, however, employers are eligible for a tax credit that reduces the effective tax rate to 0.6%, provided they follow the federal rules that dictate the jobs covered by UI. Employers in states subject to the “credit reduction state” see a 0.3 percentage point increase in their effective tax rate each year until the loan is paid back. This system is elegant in that it allows states to borrow to meet the needs of their UI systems, and also provides a mechanism for these loans to be paid back over the long-term through gradual tax increases, so as not to hamper an economic recovery.
While UI trust fund solvency is not a major concern at the moment, effective benefit administration has proven particularly challenging for states in the context of COVID-19. As of last month, nearly a third of benefits owed to eligible unemployed workers have gone unpaid, and many individuals have been waiting for months.
In order to receive federal funding for UI, states are required by the federal government to deliver benefits promptly and efficiently. Unfortunately, many states are clearly falling short in this regard, given the high levels of unpaid benefits. This problem can be partially attributed to outdated computer systems, with many would-be beneficiaries confronting crashed websites and busy telephone lines.
Congress should address these administrative challenges by leveraging the UI financing system. One potential option is to require states to take steps to improve the administration of UI benefits in order to receive federal loans for insolvent trust funds. While the CARES Act included provisions designed to improve administration, these clearly did not go far enough. Congress should ensure that the UI program is effectively delivering the support that displaced workers are owed and desperately need.