Unemployment Insurance: How Much More Will It Cost?

Employers pay and pay for laid-off workers' unemployment benefits as the time for reform draws near

By Susan J. Wells Jul 1, 2009

July CoverThe debate about how to pay the increasing cost of unemployment insurance is pitting employers against state and federal legislators. The situation has become acute: In a growing number of states, unemployment trust funds are in danger of running dry. The federal government passed emergency extensions for benefits not once but twice. And state administrators report problems handling the large numbers of claimants.

All of this heightens pressure on HR professionals who help their companies administer unemployment insurance (UI) for displaced employees.

Perhaps no other state reflects these tensions more than Michigan, recently shouldering the nation’s highest unemployment rate of 12.9 percent in April.

That month, a coalition of employers representing 16 of Michigan’s largest business groups called on state lawmakers to reject a one-time payment from the federal government in exchange for permanent expansion of the state’s employer-financed unemployment system—and increased payroll taxes to pay for it. Analysis by the coalition estimates that costs, in the form of higher State Unemployment Tax Act and Federal Unemployment Tax Act (FUTA) payroll taxes—some $69.7 million more annually—could exceed the one-time federal funding of $138.9 million in about two years. Legislators in Florida and Virginia declined the federal money this spring.

“Increasing payroll taxes isn’t going to help turn the economic situation around,” protests Wendy Block, director of health policy and human resources for the 7,000-member Michigan Chamber of Commerce in Lansing. “We understand the need to help our state’s unemployed. But the long-term tax increases on Michigan employers will damage our state’s business climate. It puts an even further squeeze on employers in our state—akin to pouring gasoline on a fire.”

The Proposals

At issue—in Michigan and elsewhere—are strings within the American Recovery and Reinvestment Act (ARRA) of 2009. President Barack Obama’s economic stimulus plan contains several changes to UI. Among them are reforms encouraging states to modernize UI by increasing benefits and expanding eligibility. Given that the cost of these changes is borne by the states and financed, of course, through unemployment taxes on employers, states were offered $7 billion to help fund these changes.

The payments are available to states that expand eligibility for UI benefits in specific ways. Each state receives one-third of its share when it uses the most recent wages to determine UI eligibility. That means analyzing the last four quarters worked, instead of the first four of the last five, as is usually done.

How much would it cost to fund such a change? The California Chamber of Commerce, for example, estimates that the state’s now-struggling UI fund would pay out an additional $50 million to

$70 million per year if officials base their benefit computation on recent wages.

The state’s UI fund heads toward multibillion-dollar deficits: In 2009-10, California expects to pay $29 billion in benefits, but will collect just $11 billion through payroll taxes. Counting the small positive balance at the end of 2008, the result will be a $6.2 billion 2009 shortfall and a $17.8 billion 2010 deficit, according to a May forecast by the state’s Employment Development Department.

Each state gets the remaining two-thirds of its share when it adds two of the following four provisions:

  • Pay UI to individuals seeking only part-time work.
  • Ease qualifying requirements for workers who quit because of certain family responsibilities—such as workers who leave to escape domestic violence, to care for an ill family member or to follow a spouse who moves to a new job.
  • Extend benefits to workers in training who exhaust regular UI.
  • Increase weekly benefits for any dependents.

New Jersey was the first state to receive its entire share of the incentive payment: $206.8 million. Connecticut, Illinois, Massachusetts, New Hampshire and South Dakota’s applications for the first third of their shares have been approved, and these states have received $200.3 million. Other state applications are pending for either their first third or entire shares.

The four changes above also cost employers more. How much more? In Michigan, legislators estimate that part-time extensions would cost $17.2 million a year; family leave, $15 million; job training, $52.5 million; and increasing the dependent allowance, $219 million.

Opposition to Change

Officials in some states say the federal money comes with too many strings.

They say the proposals will lead to higher unemployment taxes for businesses, and claim that the plans ignore the cornerstone objective of a UI system created to help individuals unemployed due to no fault of their own and actively seeking and available for full-time work.

“The modernization options are neither targeted nor temporary,” warns Doug Holmes, president of the UWC–Strategic Services on Unemployment & Workers’ Compensation, a Washington, D.C.-based business organization. “There are legitimate and serious administrative cost and policy issues associated with each of these provisions.

“Unemployment insurance is intended to be a temporary wage-replacement program. That is what it is funded for and what it should be designed to do.”

On the flip side, UI changes woven into the package can’t come too soon for observers who say the nation’s safety net shows age.

“The Recovery Act is, without a doubt, the single most significant piece of federal UI legislation in over 30 years,” says Ray Uhalde, senior advisor to the secretary of labor. “In addition to addressing the urgent needs brought on by the recession, the Recovery Act brings long-overdue recognition to the fact that, since the 1930s—when the UI program was created—the economy’s changed, the workforce has changed, and the way we work has changed.”

Pursuing Effective Reform

Experts on UI demand an update, and their research may shape reforms.

Lori G. Kletzer, a professor of economics at the University of California, Santa Cruz, and Howard Rosen of the Peter G. Peterson Institute for International Economics in Washington, D.C., are authors of one of two reform proposals published in 2006 by the Brookings Institution in Washington, D.C.

Their research proposes three broad policies to make UI responsive to today’s economy and labor force. They propose:

  • Stronger federal guidelines to end disparities in eligibility and benefit rules among the states and extend coverage to a broader group of workers. They argue that variation in state programs has become a drawback of the existing UI system. It leads state officials to fear that creating more-generous programs will harm their abilities to compete for business. The interstate competition leads to a “race to the bottom” in benefits, Kletzer explains.
  • “Personal accounts” for self-employed workers, allowing them to contribute pretax money with matching federal grants of up to $200 a year, to cushion income drops or pay for job training and searches.
  • Wage insurance to offset declines in income for a period of years when workers switch to jobs paying less than they had been making.

In the second paper, Jeffrey R. Kling, Ph.D., Brookings’ senior fellow and deputy director of economic studies, proposes a more radical overhaul: scrapping the existing UI and replacing it with personal accounts and loans to help people through short-term joblessness, and a large program of wage-loss insurance to help low- and moderate-income workers when forced to take new jobs at lower salaries.

By curbing government payments to those who experience only short-term joblessness, he says, this plan could operate with the same total amount of government support and business dollars as the current system but would provide more to the neediest.

Yet another view comes from Wayne Vroman, Ph.D., an economist with the Urban Institute in Washington, D.C. He says “the biggest problem facing state UI programs is inadequate funding.”

In a February paper, he advocates raising the FUTA tax base above the present level of $7,000 per covered worker and indexing the amount by tying the federal tax base to growth in average wages. He recommends providing states with financial incentives to increase trust fund reserves, increasing access to UI benefits and adding federal dollars for UI administration.

Heidi Shierholz, Ph.D., a labor market economist with the Economic Policy Institute, calls UI an “automatic economic stabilizer.” She says extending and expanding UI is one of the most efficient forms of stimulus spending aside from food stamps. “It gets money to people who are the most likely to have depleted their savings, and who tend to have no choice but to quickly spend essentially every dollar they receive on necessities found in their local economy.”

Yet business advocates suggest an alternative solution to the UI system’s shortfalls might be getting more aggressive about preventing fraud.

“We understand the need to help Michigan’s unemployed. However, a better alternative to accepting this one-time revenue would be to look for cost-saving reforms within the current unemployment system,” says the Michigan Chamber’s Block. For example, based on Department of Labor (DOL) data, Michigan’s Unemployment Insurance Agency paid approximately

$98 million in 2007 to claimants who were working while fraudulently collecting UI.

“If the state of Michigan did a better job in detecting fraud, we could possibly return anywhere from $67 million to $100 million or more per year back to the state’s unemployment system,” she says.

Nationally, the UI overpayment rate attributable to fraud climbed to 2.8 percent in 2008, up from 1.9 percent in 2001, according to the DOL.

As the nation continues to debate UI reform, a growing number of states’ UI trust fund accounts are nearing insolvency. According to a March analysis of trust fund health by the National Association of State Workforce Agencies, 14 states have federal trust fund loans and 18 other states’ accounts now lie below federally suggested solvency levels—for a total of 32 states with less-than-favorable UI financing.

Will Reform Trump Timing?

UI represents the sixth-largest supplement to payroll that employers shell out, notes Urban Institute economist Vroman. “So, it’s guaranteed that it will be an issue for some time to come.”

He predicts that officials in some states will wait to gauge UI modernization proposals, “making policy decisions once the economy plays out more.”

Yet it’s a question of timing: “Suggesting UI tax increases as well as benefit increases in the current environment may well raise questions,” Vroman says. “However, the need for UI reform seems clear, and prospects for reform may be best in the current situation because the UI program is on everyone’s radar.”

The author, a business journalist in the Washington, D.C., area, is a contributing editor of HR Magazine.

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