What’s Behind the Withering Reach of Unemployment Insurance? Exploring Post-Recession Action in the States
Following recessions, states often respond to financial shortfalls by curtailing unemployment insurance (UI) benefits while failing to carry through on the automatic tax increases built into the system that would help prepare for the next economic downturn. The predictable result is a vicious cycle in which state action erodes the UI system’s ability to accomplish its goals of supporting households and providing a timely infusion of cash into the economy. This has already begun in the aftermath of the COVID-19 recession, with states such as Iowa and Kentucky reducing the maximum duration of UI benefits, weakening the UI system’s ability to respond effectively to the next economic downturn even as the chances of a recession in the near future continue to rise.
Recessions Deplete UI Trust Funds, But States Don’t Save Enough in Good Economic Times
During economic downturns, high unemployment forces states to pay dramatically higher amounts in UI benefits, depleting their unemployment trust fund accounts. When those accounts run dry, states borrow money from the federal government to cover their UI commitments. However, these loans must be paid back during the following economic recovery, and states are expected to replenish UI trust funds before the next economic crisis.
If a state has an outstanding loan balance on January 1 for two consecutive years and does not repay the full amount of its loans by November 10 of the second year, the effective federal unemployment tax rate faced by employers in that state increases automatically by 0.3% each year, from 0.6% up to 6%, until the loan is fully repaid. (In the figure below, this tax revenue is denoted “Automatic debt repayments.” See How Is the Unemployment Insurance Program Financed? for details on the UI trust fund accounts.)
The federal government enacted UI with the expectation—but not the requirement—that states would also levy higher state unemployment taxes to rebuild their UI trust fund accounts when the economy is strong. Each state has the policy framework in place to achieve this goal, with triggers for higher tax rates once reserves drop below certain levels, but many legislatures sidestep these tax increases and instead cut benefits.
As a result, state trust fund accounts are chronically underfunded and unprepared for unemployment spikes. The Department of Labor defines minimum adequate solvency as reserves sufficient to pay out benefits for one year at the “high–cost rate,” equal to the average cost from the three highest-cost years of the past 20 years. (This level of solvency is considered a “high–cost multiple” of one.) As of January 1, 2022, only 16 states meet that threshold; the national average has not met that minimum standard since 1990.
During the Great Recession, at least 35 states borrowed money from the federal government after exhausting their unemployment trust fund accounts, accumulating net trust fund debt of $31 billion (and reducing their high-cost multiple to zero). As the economy improved and the two-year moratorium on loan interest expired, many states opted to reduce recipient benefits rather than increase employer taxes.
Following record unemployment during the COVID-19 recession, states faced many of the same pressures. By the beginning of 2021, 18 states had a combined $46 billion in outstanding federal UI loans, and the net trust fund balance stood at −$21 billion. In response, at least nine states have proposed or passed legislation to curtail UI, generally by reducing the maximum length of time workers can collect UI benefits. These decisions to change the UI benefit structure are being driven by financial pressure following economic downturns rather than any careful assessment of workforce needs.
Cutting Benefits to Repay State Debt
Between 1970 and 2011, all states provided UI benefits for up to at least 26 weeks. In 2012, however, six states reduced the maximum duration of benefits; by 2020, 10 states offered 20 or fewer weeks.
Six of the 10 states with reduced UI durations increased the maximum duration during the first two years of the COVID-19 pandemic, but those increases did not last, and new post-recession reductions have begun. For example:
- In Iowa, Governor Kim Reynolds made cutting the maximum duration of UI from 26 weeks to 16 weeks a major policy priority in an effort to support UI trust fund solvency, and the state legislature has obliged, approving legislation she signed in June.
- Oklahoma’s legislature passed a bill in June cutting the duration of UI benefits from 26 weeks to 16 weeks, though that legislation will not take effect until 2023.
- Legislators in Kentucky recently overrode Governor Andy Beshear’s veto of a bill that would index UI duration to the state’s unemployment rate, cutting the maximum duration from 26 weeks to only 12 weeks when unemployment is 4.5% or less and to 24 weeks when the unemployment rate is higher than 10%. That same month, Beshear signed legislation preventing any state payroll tax increases for the second straight year.
Meanwhile, the average length of time that a worker spends unemployed has trended upward for decades. This reality combined with cuts to the duration of state benefits mean more and more unemployed workers end up exhausting their eligibility for UI benefits before securing a new job, contributing to the decades-long decline in the share of jobless people receiving unemployment benefits, known as the UI recipiency rate.
Between the Great Recession and the recession caused by COVID-19, the recipiency rate stagnated between 25% and 28%, the lowest level on record, despite a fairly typical unemployment rate. In February 2017, for example, the unemployment rate of 4.6% matched that of July 2001, but the recipiency rate of 28% was 19 percentage points lower, demonstrating the extent to which UI’s reach and efficacy have withered.
The Cycle Continues
As of the beginning of 2022, 10 states still held outstanding loans totaling $40 billion, and most states cannot pay out a single year of benefits with reserves alone. Already, some states have responded to the cash crunch by cutting benefits, convinced that jobs are available for those who want them and hesitant to raise payroll taxes during an economic recovery with COVID-19 continuing to linger. But lowering benefits today curtails the UI system’s ability to buffer household finances and stabilize the economy in future downturns. So far, that is a tradeoff many states have been willing to make.
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