(August 11, 2008) A sluggish economy combined with the predicted impact of huge benefit increases adopted without counterbalancing reforms are pushing the employer-funded state unemployment insurance (UI) fund toward bankruptcy for the second time in less than a decade.

According to the May 2008 Unemployment Insurance Fund Forecast published by the Employment Development Department (EDD), the UI Trust Fund balance was $2.4 billion at the end of 2007. The fund is projected to have a balance of $1.1 billion at the end of 2008.

Further strain may come at the end of 2009 when the report concludes the fund could be in a deficit.

Surplus to Bankruptcy

In 2001, the UI Trust Fund had a surplus of nearly $6 billion. Legislation passed that year mandated a 95 percent increase in benefits over a three-year period, without providing for offsetting reforms in eligibility standards or tax relief that historically accompany such benefit increases.

Legislation passed in 2002 retroactively applied the benefit increases approved the previous year, which resulted in nearly  $1 billion in additional payouts.

These benefit increases, combined with an economic downturn, reduced the fund to bankruptcy in 2004.

To continue paying benefits, California took out an emergency loan of $1.4 billion from the federal government for the first time in the state’s history and increased taxes on employers to the maximum “F” level plus a 15 percent surcharge, the highest allowed by law.

Subsequent economic growth and job creation in California temporarily improved the fiscal health of the fund, which skirted insolvency at the end of 2004 with a razor-thin reserve of $397 million.

Maximum Tax Rate

Now, even though employers have been paying the maximum allowable rate since 2004, the fund is projected to be insolvent in 2009, according to the EDD report.

As of June, unemployment rates had reached 6.9 percent, the highest since the year before the UI Fund went bankrupt. UI benefit payments are projected to be $6.5 billion in 2008 and $6.6 billion in 2009, for a total of $13.1 billion.

Total tax receipts for the UI Fund are projected to be $5.2 billion in both 2008 and 2009, for a total of $10.4 billion.

If the economy fails to improve, causing demands on the fund to outstrip tax receipts, California would be forced to borrow more money in order to meet its payment obligations to qualified individuals.

Increasing Debt Load

Under normal conditions, employers pay a Federal Unemployment Tax Act (FUTA) rate of 0.8 percent on the first $7,000 in wages paid to each employee annually.

If the state continues to borrow and has a federal loan amount outstanding by November 10 of the second year, employers in the state lose the tax credit for the federal unemployment tax they pay, in effect increasing the employer tax rate and boosting the tax per employee by 37.5 percent.

For each year the state still owes on the federal loan, employers’ tax credit declines and the effective tax rate increases. By the fourth year of an outstanding loan, for example, the federal tax employers pay would have more than doubled, from $56 per employee to $119 per employee, according to EDD.

Interest on the federal loan cannot be repaid out of the state’s UI Fund, making it likely that the General Fund would have to be tapped for that amount instead.

EDD reports that over the years, UI programs of about 75 percent of the states have borrowed from the federal Treasury, while six states have secured private loans to cover their UI benefit payment costs. Eight states borrowed from the U.S. Treasury between December 2002 and December 2004.

In 2004 and 2005, New York failed to repay the federal government, triggering an increase in employers’ federal unemployment tax rate. New York employers also paid an interest assessment surcharge to repay interest on the federal loan.

New York’s fund returned to a positive balance in 2006, but the state has extended the surcharge through 2008 in case it is needed again, according to EDD. As of 2007, the New York fund measured very low on a solvency scale that includes a comparison of benefits paid to UI tax revenues.

 Video: Robert Callahan Talks About Unemployment Insurance