Underfunded and Undervalued
Involuntary unemployment, whether expected or sudden, is often a financially and emotionally devastating experience. To help workers and their families face the economic challenges following job loss, the unemployment insurance (UI) system provides partial wage replacement for workers unemployed through no fault of their own.
The UI system proved especially critical during the recent recession, as countless jobs vanished from every industry across the state and unemployment rates skyrocketed. Hundreds of thousands of working families survived on little other than UI benefits, and as the economy recovers, many more will continue to rely on this critical lifeline.
The recession dealt a heavy blow to the overall health of our unemployment insurance program, but even more concerning are structural deficiencies endemic to the California system. Chronic underfunding guarantees ongoing solvency risks as well as sudden tax hikes on employers during tough economic times. Only drastic measures, like raiding the worker-funded Disability Insurance program, have kept the system afloat. As a result of this highly irresponsible and shortsighted funding structure, our UI trust fund currently owes $10.5 billioni to the federal government.
Unemployment insurance is a social insurance program designed to help workers meet their core financial obligations after losing a job. The federal government sets basic rules to administer the program, and each state determines its own eligibility rules, benefits and tax levels.
The state UI system is funded by employer contributions. Premiums are experience rated, meaning that employers who lay off more workers are supposed to pay higher rates, but premiums are paid on a small percentage of overall wages—the “taxable wage base.” In California, the taxable wage base is $7,000, so employers only owe premiums on the initial $7,000 of wages. Other states maintain taxable wage bases of $20,000 – $30,000, or more. This means that employers in these states face UI tax bills several times larger than those paid by California employers.
Workers qualify for unemployment benefits only if they are unemployed through no fault of their own, meet certain earnings standards, and are actively seeking new employment. Workers are generally eligible for up to 26 weeks of state benefits per claim, depending on their prior earnings. In times of particularly high unemployment, the federal government has typically enacted an extension of unemployment benefits that varies depending on the unemployment rate in the state.
The current federal program is called Emergency Unemployment Compensation (EUC) and took effect in July 2008. EUC now provides California and other high unemployment states with an additional 47 weeks of federally-funded benefits. Until January 1, 2014, California’s unemployed will qualify for up to 73 weeks of federal benefits—26 state-funded and 47 federally funded.
California’s current benefits range from $40-$450 a week, with each worker’s benefit amount based on his or her prior earnings. Weekly benefits currently average $297, and the same weekly benefit amount is paid regardless of whether a claimant is receiving state or federal benefits. A common metric used to measure the value of a state’s UI benefits is the “weekly wage replacement rate,” or average weekly UI benefits divided by average weekly earnings lost due to unemployment. For example, a worker earning $1000 per week would likely collect $450 in weekly UI benefits, producing a 45% wage replacement rate for that individual. The “wage replacement rate” is then the average for all UI claimants.
States usually work to achieve benefit levels that offer a 50% wage replacement rate. However, California’s 29% weekly wage replacement rate is 7th lowest in the nation. In addition, these estimates don’t account for differences in the cost of living. A percentage adjusted to reflect California’s high cost of living would likely put our state at the bottom.
UI benefits not only help the unemployed worker through tough times, but they also provide a valuable boost to local economies. Economists estimate that for every $1 spent on unemployment benefits, $2 worth of economic activity is generated; creating a “multiplier effect” that means vital assistance for depressed communities.ii In California, the federal extension of unemployment benefits alone has pumped over $40 billion into the state’s economy, not counting the significant multiplier effect.
While states are not required to reimburse the federal government for EUC benefits, if a state has borrowed federal money to pay regular (state-funded) benefits, the state must pay annual interest on the outstanding amount while the debt is being repaid. California’s $10.5 billion debt generates roughly $300 million in annual interest expenses, and so far two of these annual interest payments have been made—both from the 100% worker-funded Disability Insurance (DI) fund. In other words, California’s UI system is so broken that workers are now bailing out their employers.
PROBLEMS WITH CALIFORNIA’S UI SYSTEM
The recent downturn is clearly to blame for much of the fund’s poor condition; however, long-standing flaws in the system’s funding structure laid the groundwork for our current debt. Indeed, in 2007, California’s trust fund had only enough reserves to pay benefits for four months at recession levels, the 9th lowest in the nation heading into the Great Recession. Absent a major overhaul, our system will continue to dip into insolvency as a matter of course—needlessly generating extra costs for employers and inspiring political attacks on workers.
Also, the UI benefits structure results in an erosion of the value of benefits over time and existing eligibility standards exclude many unemployed workers. Both the funding and benefits systems need to be updated to stabilize the program’s finances and to better serve laid-off workers.
California’s UI Funding System is Structurally Flawed
Low Taxable Wage Base: Since 1983, California businesses have only been paying UI taxes on the first $7,000 of each worker’s earnings. In 1983, that represented about 1/3rd of the earnings of the average California worker. Today, it’s less than 1/7th.iii This wage base is the minimum allowed by federal law and ties California for last in the nation with Arizona. However, considering that California’s average annual wages exceed Arizona’s by 19%, California’s taxable wage base ranks last by a significant margin.
Across the country, the average wage base for UI taxes is nearly twice that of California,iv and our neighboring states maintain much larger taxable wage bases. For example, Nevada and Oregon charge UI taxes on the first $26,900 and $34,100 of wages, respectively, and Washington’s $39,800 taxable wage base is well over 500% of California’s. As inflation and wages rise, our UI fund will be perpetually underfunded unless the taxable wage base is increased and indexed. By way of comparison, seventeen other states have indexed their taxable wage bases and all of those states enjoy a much healthier UI fund than California. These seventeen states, including Oregon and Washington, were also far less likely to borrow from the federal government to finance their state unemployment benefits.
Weak disincentives to lay off workers: Another concern is that the tax rate structure faced by California’s employers insufficiently discourages employers from laying off workers. The rates vary according to a schedule that charges all employers higher taxes in times of lower fund reserves. Employers currently pay at the maximum allowable tax rates, called the F+ schedule. An additional 15% “emergency solvency” surcharge is also in place.
An individual employer’s rates are then experience rated to reward employers who’ve managed to avoid laying off workers. However, experience rating in practice does not seem to be adequately discouraging layoffs. While some difference does exist between what the highest and lowest layoff-producing employers pay under the F+ schedule, the gap is insufficient to create a real disincentive against layoffs—especially for employers already paying the maximum rates. Higher top rates and additional steps in the tax schedule would strengthen the financial incentives for employers to avoid layoffs.
Tax rates rise when the economy goes down: The current pay-as-you-go mechanism for maintaining the UI fund balance runs counter to economic logic. By ratcheting up tax rates during economic downturns (when claims rise and the fund balance falls), the system requires employers to contribute more when it is the most difficult to do so. Other states, including Oregon and Washington, use a forward-funding, or counter-cyclical, mechanism for their UI funds, which fills the funds during better economic times to ease pressure during downturns. Without addressing these structural flaws in California’s unemployment insurance funding system, the state fund will routinely face insolvencies during economic declines and the intended disincentives of an experience rated system will be blunted, undermining job stability for California workers.
Federal loans generate massive interest costs: In addition, the $10.5 billion debt generates a federal tax increase on employers to pay back the principal on the federal loan and hundreds of millions in interest each year. To reduce the principal, California employers will face a federal tax increase averaging about $84 for each worker in 2013. This amount will increase each year until the outstanding loan amount is fully repaid.
Federal law prohibits UI funds from covering the interest charges by these loans. To pay the interest in 2011, that year’s general fund budget borrowed $303.5 million from the State Disability Insurance (DI) Fund. In 2012, an additional $308.2 million loan was necessary.v The DI fund is generated entirely from worker contributions and designed for paid family leave or disability insurance claims—not unrelated general fund shortfalls or interest payments to the federal government. (Note that the 2013 budget plans to avoid another DI fund loan by using general funds.)
The two DI fund loans were necessitated by the fact that California, unlike other states, operates with no system in place to automatically handle these interest charges. These interest payments come due in September of every year in which loans are outstanding, leaving policymakers and budget writers to cover massive interest bills by a very strict annual deadline. So far, the solution has been to borrow from our DI fund, but this method is as unsustainable as it is unfair. 20 other states levy special surcharges on employers to deal with this interest, California should join them and end this irresponsible cycle of borrowing.
California’s UI Benefits Structure Fails Unemployed Workers
Like the taxable wage base, California’s benefit allowances for unemployed workers are static. As a result, when wages and the overall cost of living rise, benefits fail to keep pace. California already ranks 43rd in the nation for the percentage of the state’s average weekly wage that is replaced by its UI benefits – just 29%. Most of the 36 states that automatically index their benefit amounts do so in relation to the state’s average weekly wage, guaranteeing that benefits won’t be eroded over time. Without indexing UI benefits, California’s benefits will continue failing to meet workers’ needs.
California’s unemployment insurance benefits also do not account for the size of a family dependent on UI payments. While individuals receiving benefits are somewhat more flexible in reducing costs in times of unemployment, families with children often face fixed costs—such as education and child care—that are difficult to offset or suspend during a job search. To acknowledge this variation in family needs, thirteen other states have created a dependents’ allowance, making benefits more progressive for working families.
FIXING CALIFORNIA’S BROKEN UI SYSTEM
It is clear that changes are needed to get the unemployment insurance fund in balance and to make the benefits work better for laid off workers. To meet these goals, the California Labor Federation recommends the following:
Fixes for Fund Solvency
- Increase and index the taxable wage base. To bring the UI fund into balance and keep up with rising inflation and wages, the taxable wage base must be adjusted upward now and should be indexed to automatically rise over time.
- Expand the tax rate schedule. Without changes to the UI tax rates, especially the top tax rates, the value of an experience-rated system will be lost along with the incentive to keep workers working.
- Move to a forward-funded system. Rather than waiting for an economic downturn to replenish the fund, California should use economic booms to grow the balance of the UI fund when it is financially easiest for employers to pay more.
- Establish an employer surcharge to repay federal loans. California should join the 20 other states who levy a special assessment on employers to cover the cost of federal loans.
Fixes for Unemployed Workers
- Index benefits to account for rising wages and inflation. By pegging benefits to a percentage of the state’s average weekly wage, California can ensure that benefits will track wages and provide a similar value to workers over time.
- Create a dependents’ allowance. Adding a dependents’ allowance helps the unemployment insurance system keep families out of poverty during periods of job loss.
(i) United States Department of Labor. UI Budget. Last accessed 12 February 2013.
(ii) Vroman, Wayne. The Role of Unemployment Insurance As an Automatic Stabilizer During a Recession. Impaq International. Jul. 2010. Last accessed 17 Feb. 2012.
(iii) BLS. May 2011 State Occupational Employment and Wage Estimates California. US Bureau of Labor Statistics, 27 March 2012. Last accessed 14 December 2012.
(iv) USDOL. Significant Measures of State Unemployment Insurance Tax Systems. November 2012. Last accessed 14 December 2012.
(v) EDD. October 2012 DI Fund Forecast. Last Accessed 14 December 2012.