Presentation at the 2010 GOVERNING Conference: Outlook in the States and Localities, Washington, D.C., February 2010
Senior Fiscal Analyst
Southern Legislative Conference of
The Council of State Governments
As the national economy warily recovers from the Great Recession, state finances continue to face monumental challenges in grappling with the sharpest drop in tax receipts in decades. And, even after slashing their budgets substantially in fiscal year 2009, states are staring at new mid-year gaps that have opened up in the current fiscal year (2010) with more gaps forecasted for fiscal years 2011 and 2012. While none of this is new information, what makes the state fiscal outlook quite daunting is that the current revenue shortfalls and huge budget gaps masks a number of enormous fiscal challenges looming in such areas as healthcare, education, public pensions, emergency management, infrastructure, transportation and unemployment insurance. States will have to contend with these significant challenges once the current crisis abates.
My goal this morning is to focus on one of these sizable spending categories—unemployment insurance—and provide a snapshot of where states stand, how states ended up here, what states are doing to deal with the ongoing crisis and highlight a model state program that might be replicated.
Part 1: Where Do States Stand?
The nation’s unemployment insurance program emerged out of the Great Depression when in 1935 President Roosevelt settled for a compromise plan that allowed states the option of participating in the program while maintaining a great deal of latitude in devising the specifics of their plans. Some states, such as Wisconsin, already had their own unemployment program before this federal initiative while others introduced their plans later. The major objective of the program still revolves around functioning as an automatic economic stabilizer: providing the unemployed funds to take care of essential expenditures, thereby maintaining household purchasing power and ensuring economic activity during a downturn or recession.
The current federal-state unemployment insurance program provides unemployment benefits to eligible workers who are unemployed through no fault of their own and who meet other eligibility requirements specified by state law. This temporary financial assistance is administered by the individual states within broad guidelines established by federal law. Based on the compromise reached during the Roosevelt Administration, eligibility for unemployment insurance, benefit amounts, length of time benefits are available, are all determined by the particular state’s law. The main source of benefit funding in most of the states is a tax imposed on employers with only three states requiring minimal employee contributions (Alaska, Pennsylvania and New Jersey). Nationally, the average tax is about 0.6 percent of total wages and the average weekly check is about $311 with significant variations from state to state. While the benefits are funded by the payroll tax, firms that dismiss a significant number of workers pay a higher tax. The federal government absorbs the administrative costs of the program and in a steep recession, like the current one, also pays for the extension of benefits beyond the usual 26 weeks.
As a result of the severity of the Great Recession, the doggedly high unemployment rates in so many states, the actions taken by states (such as expanding benefits and cutting taxes) the unemployment insurance funds in a majority of the states are in perilous shape. The funds are being attacked at both ends: more people are tapping benefits while a fewer number of companies are paying taxes to replenish the funds. The federal government forecasted in late December 2009 that an estimated 40 state programs will be broke within two years and projected that these programs will need an estimated $90 billion in federal government loans to keep issuing unemployment checks. Already, as of January 28, 2010, 26 states—ranging from California to North Carolina to Illinois to Rhode Island—have borrowed nearly $31 billion from the federal government to make benefit payments.
The dire financial position of state unemployment trust funds is apparent from these details. Based on U.S. Department of Labor data, in the first quarter of 2001, the last time the U.S. economy plunged into recession, the total state unemployment trust fund balance was $49.9 billion. In the first quarter of 2008, a short while after the Great Recession began, these trust fund balances had plummeted to $32.4 billion. For the latest available quarter, the third quarter of 2009, state trust fund balances stood at an alarming $14.2 billion, the prime reason behind the dozens of states being forced to tap the federal government for emergency loans.
Experts tracking state unemployment insurance trends maintain that trust fund balances alone are not a useful reflection of trust fund solvency levels and often rely on different solvency measures. Among these are the following: the Average High Cost Multiple (AHCM), which measures the number of years a state could pay unemployment insurance benefits at peak recessionary levels; the High Cost Multiple (HCM), which incorporates the state’s own eligibility requirements, benefit history and unique experience with periods of high unemployment over several decades; and, the state’s trust fund reserves relative to total payroll. In the first two measures, the recommended threshold is 1.
Unfortunately, the current financial position of state trust funds when assessed by both the AHCM and HCM measures remains very bleak. Only 13 states exceed the recommended threshold under the AHCM category and a meager 8 states exceed the recommended threshold under the HCM category. The balances in 4 states, Indiana, Michigan, New York and South Carolina are almost depleted and essentially have zero balances. In sum, the trust funds in 37 states are “broke” or “near broke” with reserves well below the recommended level.
Part 2: How Did States End Up Here?
A number of factors drove state unemployment trust fund balances to their present woeful condition and the persistently high state unemployment rates of the Great Recession ranks as an important reason. The latest national unemployment rate (December 2009) is 10 percent and it is expected that this rate will climb even higher before declining. When those underemployed—those who have given up looking for work and those working part-time for lack of full-time positions—are factored in, the rate stands at a staggering 17.3 percent. The average duration of unemployment in December 2009—29 weeks—was the longest since the government began tracking such data in 1948. All 50 states ended 2009 with higher unemployment rates than a year earlier. In fact, by December 2009, 16 states had double-digit unemployment rates with Michigan, Nevada, Rhode Island, South Carolina and California topping the list. Of note, every one of these 16 states with the exception of Mississippi, Oregon and Tennessee have secured loans from the federal government to bridge shortfalls in their unemployment trust funds.
Another reason for the paltry fiscal position of the funds relates to the rate cuts enacted by states in the last decade. Indiana, in 2000, lowered its tax rate and since then, the state’s trust fund has gradually evaporated, forcing the state to borrow $1.6 billion from the federal government. Michigan is another state that lowered taxes in 2001 to unsustainable levels and the state has been forced to borrow $3.4 billion from the federal government.
Also, eroding the financial position of the trust funds were state actions to enhance benefits while maintaining and/or lowering tax rates. California, for instance, in 2001, doubled unemployment benefits and ever since then, the state’s fund has been in poor fiscal shape. Even in 2004, a relatively “good” year for state finances, California had to borrow from the federal government and now owes $6.9 billion. In Ohio, state law calls for benefits to increase annually though there is no provision for taxes to do the same and now the state is $1.9 billion in debt to the federal government. As mentioned, Indiana is another state with a troubled program partially because in 2000 it expanded benefits without securing additional revenue.
Part 3: What Are States Doing?
In addition to securing emergency loans from the federal government, states are now raising taxes and/or slashing benefits. Both these actions come at a most inopportune time: employers, already crushed by the slumping economy and dwindling revenues can ill afford another increasing expenditure category and unemployed workers, reeling from the loss of employment, have to now deal with shrinking benefits and shrinking benefit payments.
In 2010, 36 states will increase the tax charged on businesses for unemployment insurance; in 2009, the average business paid $95 per employee while in 2010, it will shoot up to $171. While the increase per worker ranges from $41 in Arkansas to $187 in Nebraska to $259 in Maryland to $980 in Hawaii, businesses will undoubtedly struggle to make these additional payments. These tax increases are the result of both the tax rates going up and/or the taxable wage base going up. In West Virginia, for instance, the unemployment insurance tax is now based on the first $12,000 of an employee’s wages, up from $8,000, the first time the wage base changed in the state since 1981. Some of these increases are related to automatic triggers that go into effect; for instance, in Georgia, when the state’s reserve ratio falls below a certain percent, the state’s Labor Commissioner has "the option of imposing an increase in the overall rate of up to 35 percent." In Florida, a state that has already borrowed $1.2 billion from the federal government, Governor Crist announced last week that he would delay the increase in the tax levied on employers. While this action by the governor ensures that Florida employers would not see an increase in their payments, it also confirms that the state will continue to seek federal government help with its finances.
On the other side of the equation, at least seven states will slash, freeze or limit benefits to unemployed workers in 2010. In Pennsylvania, all unemployed workers will see a 2.4 percent reduction in their benefit checks. West Virginia has frozen state benefits at the current level while out-of-work Virginians collecting unemployment benefits and Social Security benefits will see their unemployment checks sliced by half the Social Security amount. New Hampshire has instituted a one-week waiting period before benefit checks flow. Hawaii has proposed cutting its maximum benefit check by as much as a third, about $190, per week. A state task force in Kentucky has recommended trimming weekly benefits by nearly 10 percent while South Carolina legislators are considering a benefits freeze.
Part 4: Model Programs
In reviewing the different state unemployment programs, Oregon’s efforts stand out. Despite being stricken with an 11 percent state unemployment rate in December 2009, the state’s unemployment trust fund is in relatively good shape. Oregon is one of just three states with a trust fund balance that exceeds a billion dollars ($1.3 billion specifically), rates high on both the AHCM and HCM measures and pays an average weekly benefit amount of $315. How did the state end up in this enviable position? In the mid 1970s, when the Oregon fund went bankrupt, the state instituted a series of reforms that have played a significant role in ensuring the solvency of its fund today. One, the state’s employers tax the first $31,300 of a worker’s wages, an amount well above the taxable wage base in a majority of states; two, Oregon’s taxable wage base increases automatically every year; three, Oregon’s tax rate is higher than the national average and the state’s eight tax schedules—in effect since 1975—require that the state move to higher tax rates in the years after high unemployment and decline during peak employment years, thereby ensuring “self-balancing;” and four, the Oregon Legislature has largely avoided tinkering with its unemployment insurance formula for years. In contrast, 7 states still only tax the first $7,000 of a worker’s wages, the federal minimum established in 1983 when the U.S. average income was about $15,000 (it is now about $55,000). Included in this list of 7 states are several with the most depleted funds: California, Florida, South Carolina and Indiana. In fact, an additional 30 states—for a total of 37 states—only tax the first $19,300 of a worker’s wages. The low average tax rate on total wages is another feature that stands out: the rate in 25 states lies below 0.6 percent, the national average.
In conclusion, while depleted unemployment insurance funds are yet another surging expenditure category plaguing state finances, the emergency loans from the federal government offer only temporary reprieve: taxpayers in states that have borrowed billions will have to repay the federal government the principal and tens of millions of dollars in interest. Fundamental reforms, including establishing a realistic taxable wage base and a realistic average tax rate on total wages, indexing the taxable wage base to reflect even a small increase every year, refraining from slashing tax rates or expanding benefits or tinkering with the program—all initiatives pursued very successfully by Oregon—not only ensures the financial solvency of the trust fund but also allows the unemployed to receive a reasonable weekly benefit. If states move toward replenishing their trust funds during times of economic prosperity, this will ensure that the original objectives of the unemployment insurance program—acting as an economic stabilizer during bleak times—will occur. This will also mitigate the need for federal loans and consolidate the financial position of states with entities like the rating agencies. Thank you for your attention.