Stateline Story

Businesses Penalized for State Unemployment Insurance Debt

  • November 18, 2011
  • By Pamela Prah

Employers in 20 states will have to shell out more in taxes next year as a penalty for the states not paying back federal loans that kept unemployment programs afloat during the recession.

Altogether, states still owe $37.6 billion to the feds that they borrowed when their unemployment insurance trust funds sank to zero. Most states have dealt with the problem by raising state payroll taxes on employers, making benefits to workers less generous; or a combination of the two.

A handful, though, have opted to issue bonds. Idaho did it earlier this year, and Texas did it last year. And just this month, Illinois lawmakers approved legislation allowing the state to issue bonds to pay back the $2 billion the state owes the federal government for unemployment relief. Governor Pat Quinn has applauded the UI package and has indicated he will sign the measure. The state figures it will get an interest rate lower than the 4 percent it would have to pay the federal government, saving the state and businesses millions of dollars.

Laurence Msall, president of the nonpartisan Civic Federation in Chicago, called the move "reasonable and necessary" given the state's budget problems and the extraordinary demand for jobless benefits during the recession and fragile recovery. Wayne Vroman, a senior fellow at the Urban Institute who specializes in unemployment issues, says the state is "borrowing from Peter to pay Paul," noting that "it's still a debt that they will have to pay back."

California, which has received the most federal unemployment money of any state at $9 billion, has no plans to go that route, says Tom Dresslar, a spokesman for California State Treasurer Bill Lockyer.

Delayed relief

But relief for employers in Illinois won't come until the state actually issues the bond, probably sometime in 2012. So for companies in Illinois, just as in the other 19 other states facing a similar predicament, higher taxes will kick in next year whether the state passes legislation or not. The federal law governing unemployment loans to states has an automatic repayment process for those that fail to pay back their loans within a certain time. The most recent deadline was November 10.

Here's how the system works: Unemployment compensation is financed in part by state payroll taxes and in part by federal taxes under the Federal Unemployment Tax Act (FUTA). The FUTA tax rate is 6.0 percent on the first $7,000 of wages per worker. Employers, not workers, are responsible for paying the tax. But the employers usually get a credit from the federal government of 5.4 percent, so they end up paying a net tax of only 0.6 percent.

However, if a state is forced to borrow from the federal unemployment account and doesn't pay the money back in time, its credit is reduced by 0.3 percentage points in the first year. The result is that employers in states that are behind schedule will be required to pay an additional $21 per employee in federal unemployment taxes on 2011 wages. "We'll get that bill" from the feds, says David Vite, president of the Illinois Retail Merchants Association.

Employers in Illinois figure to save more than $400 million through 2019 by avoiding the higher tax that would apply if the loan is not paid off. Instead of paying $240 million in interest and penalties, Vite says, the state will end up paying only $80 million.

Unprecedented action

Facing higher taxes
Source: U.S. Department of Labor, November 2011

The recession and slow recovery have tested the country's unemployment insurance system as never before. Of the nearly 14 million Americans without jobs, nearly half rely on unemployment insurance, says George Wentworth, senior staff attorney with the National Employment Law Project (NELP), an advocacy group. Before the recession, he says, 2.5 million Americans were collecting unemployment insurance.

Workers who exhaust their regular UI benefits before they find a job can get additional weeks of benefits through temporary programs that the federal government pays for but states administer. A state map issued by the Center on Budget and Policy Priorities shows the extent of UI benefits.

Scaling back

States have taken a variety of unprecedented actions this year to help pare down their unemployment insurance debt. Because they have wide latitude in determining who is eligible to receive benefits and for how long, many states have scaled back their programs. For the first time in more than 50 years, at least six states cut the maximum benefit to less than 26 weeks.

And as Stateline has reported earlier, Florida this year became the only state in the country that links the amount of time people can collect unemployment insurance to the state's unemployment rate. As the jobless rate falls, so does the duration of unemployment benefits. Ultimately, out-of-work Floridians could receive just 12 weeks of benefits — less than half the 26 weeks offered by most other states.

Florida made the change so that it could begin paying down $1.7 billion worth of loans from the federal government taken out to keep checks going to the jobless. At least eight other states made it harder to qualify for benefits, according to an NELP report .

But few states made changes sweeping enough to shore up their trust funds and prepare for the future. "Ultimately changes are needed to break the long-term trend of not saving in good times and going bust in bad times," says Joseph D. Henchman, vice president of legal and state projects at the Tax Foundation, who in a report last month found that states routinely cut UI taxes in prosperous years and raised them in down years. The federal stimulus program handed states breathing room by extending the interest-free unemployment insurance loans through the end of 2010, but states still had to pay back the loans.

Florida, Indiana and Michigan all made changes to their UI programs this year, but those efforts weren't enough to pay off their UI debt and avoid the federal penalty. In fact, employers in Indiana will see a 0.6 percent credit reduction and Michigan an even larger one (0.9 percent) because both of these states took out loans even before the recession and haven't paid them off. South Carolina was able to avoid the penalty for 2011 because it met certain federal conditions, according to the U.S. Department of Labor.

Five other states on the Department of Labor list of states with outstanding loans borrowed the money in 2010, so they didn't face the November 10 deadline, explains Melissa Loeb, a policy analyst with Federal Funds Information for States, which analyzes and provides budget updates. States essentially have 22 to 34 months to pay off the balances depending when the loan was taken out, she says. The five states that avoided the November deadline are Arizona, Colorado, Delaware, Kansas and Vermont.

There is still one other way for states, in theory at least, to avoid the penalty. President Obama has pitched delaying the FUTA credit reduction until 2014 and suspending for another two years the interest states owe for UI loans. That idea was in the president's budget and he has proposed it again to the "super committee" charged with finding a way to cut at least $1.2 trillion in federal spending.