Unemployment insurance (UI) is a program jointly administered by the federal government and each state that provides relief to eligible unemployed workers by replacing a portion of their wages for a limited time. The U.S. Department of Labor (DOL) oversees UI while states retain significant latitude to administer their own programs.
As a result of this partnership, financing UI involves a complex set of federal and state payroll taxes, tax credits, and federal trust funds.
To fund UI, employers pay two separate payroll taxes, established by the State Unemployment Tax Act (SUTA) and the Federal Unemployment Tax Act (FUTA).
The state unemployment tax varies within and between states based on a variety of factors. Within each state, the tax rates that individual employers pay vary based on an employer’s “experience rating,” which reflects its history of layoffs. The experience-rating system ensures that the firms with a history of laying off the most workers (who then collect unemployment benefits) pay the highest unemployment tax rates. In Massachusetts, for instance, employers pay a tax rate between 0.94% and 14.37% depending on their experience rating. Tax rates within a state also vary year to year based on the state’s unemployment trust fund balance. For example, Kentucky uses six tax rate schedules based on the state’s trust fund balance, and each schedule has 22 tax rates that a company in the state could pay based on its experience rating.
Finally, the unemployment tax wage base varies by state, from the first $7,000 in wages in six states up to the first $56,500 in Washington State.
While the FUTA payroll tax rate is 6% of the first $7,000 in annual wages for each employee, most employers are eligible for a 5.4% credit. Thus, employers typically pay a net federal unemployment tax rate of 0.6% on wages up to $7,000—effectively $42 per employee annually.
An employer’s 5.4% tax credit is contingent on three factors:
- The employer has paid its state unemployment taxes on time.
- The state’s UI program abides by all DOL requirements, including using an experience rating system. (Currently, all state programs are approved.)
- The state has no outstanding federal loans for UI benefits.
States can borrow from the federal government if they do not raise enough state unemployment tax revenue to cover their benefit outlays. If a state has an outstanding loan balance with the federal government 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 5.4% FUTA tax credit automatically declines by 0.3% each year until the state repays the loan. In other words, employers in a state with an outstanding loan pay an additional 0.3% the first year, 0.6% the second, and so on.
All state and federal unemployment tax revenue is deposited into the Unemployment Trust Fund (UTF), which is overseen by the U.S. Treasury Department. The UTF contains 59 different accounts: 53 state accounts (including accounts for the District of Columbia, Puerto Rico, and the Virgin Islands), which serve as the states’ UI checking accounts; and four inter-related federal accounts.i
The Four Federal Accounts
The Employment Security Administration Account (ESAA) serves as the federal government’s UI checking account and is the first destination of most federal unemployment tax revenue. DOL then directs the Treasury Department to use these funds in one of three ways:
- To directly cover federal administrative costs for UI.
- To cover state administrative costs by dividing the funds earmarked for administrative purposes into the state accounts.
- To fund the Extended Unemployment Compensation Account.
The Extended Unemployment Compensation Account (EUCA) finances the federal government’s half of costs associated with Extended Benefits. By statute, the Treasury transfers 20% of ESAA’s net monthly activity—revenue minus distributions—into EUCA each month.
The Federal Unemployment Account (FUA) provides loans to states that do not have sufficient funds in their accounts to cover UI benefits. Two primary sources replenish FUA: loan repayments and revenue from the higher federal unemployment taxes that employers pay due to their state’s outstanding loans.
The Federal Employees Compensation Account (FECA) is used to reimburse states for UI benefits paid to former federal employees. Each federal agency transfers money to FECA to cover UI benefits for its workers.
- Congressional Research Service, The Unemployment Trust Fund (UTF): State Insolvency and Federal Loans to States, Julie M. Whittaker, October 1, 2020. Available at: https://crsreports.congress.gov/product/pdf/RS/RS22954.
- Congressional Research Service, Unemployment Compensation (UC) and the Unemployment Trust Fund (UTF): Funding UC Benefits, Julie M. Whittaker, December 15, 2020. Available at: https://crsreports.congress.gov/product/pdf/RS/RS22077.
- Congressional Research Service, Unemployment Compensation: The Fundamentals of the Federal Unemployment Tax (FUTA), Julie M. Whittaker, October 25, 2016. Available at: https://crsreports.congress.gov/product/pdf/R/R44527/5.
- U.S. Department of Labor, Employment & Training Administration, Office of Unemployment Insurance, Average Employer Contribution Rates by State, accessed February 4, 2022. Available at: https://oui.doleta.gov/unemploy/avg_employ.asp.
- U.S. Department of Labor, Employment & Training Administration, Office of Unemployment Insurance, Significant Provisions of State Unemployment Insurance Laws, July 2021. Available at: https://oui.doleta.gov/unemploy/content/sigpros/2020-2029/July2021.pdf.
iThe UTF also has two accounts related to the Railroad Retirement Board, which is beyond the scope of this explainer.
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