Monday, March 7, 2022
California is Heavily in Debt from Unemployment Payments: How to Get Out of a $20 Billion Hole?
Posted By Grace Gedye/CalMatters on Mon, Mar 7, 2022 at 4:58 PM
When California pays unemployment benefits, the money has to come from somewhere. That somewhere is the state unemployment insurance trust fund, a cash fund financed by a tax on employers. Millions have used unemployment benefits during the pandemic, depleting existing reserves, and now the state is in debt to the tune of nearly $20 billion. Most states have no debt. The debt will be paid. But how soon will it be paid, and how many taxpayer dollars will go toward it? Under the current system, it will take years of higher taxes for employers, who fund the benefits, to pay them back.
Gov. Gavin Newsom proposed using $3 billion of the state's projected $21 billion surplus to pay down that debt, plus hundreds of millions to cover interest payments on the loan, when he released his budget proposal in January. While that proposal is primarily intended to help businesses, there is no guarantee that businesses will reap a direct benefit, especially in the short term.
California's unemployment system was in an uncertain state even before the pandemic, rated the least financially stable system of the 50 states in February 2020 by the US Department of Labor. The strong economic impact of a pandemic was difficult to predict. But California's unemployment system now appears to be having unique difficulties getting back on track. If the way California funds unemployment doesn't change, economists say, we could see the unemployment system go into debt again and again.
How did we get here? California's unemployment system has an important piggy bank: the unemployment insurance trust fund. Employers invest money in it on a regular basis through taxes. Workers receive money from it when they get unemployment benefits. The federal government lent money to many states early in the pandemic to bolster their unemployment funds. But two years later, several states have paid off their federal loans, while California's balance remains the highest of any state.
A key problem is that while California lawmakers have increased unemployment benefits in recent decades, in part to keep up with inflation, money coming into the system from employers hasn't kept pace, he said. Audrey Guo, an economist at Santa Clara University who studies unemployment insurance. On top of that, more Californians have been out of work during the pandemic compared to the national average. The national unemployment rate rose to 14.7 percent in April 2020 and fell to 8.4 percent in August 2020, according to data from the Bureau of Labor Statistics. But California's unemployment rate shot up higher and didn't recede as quickly. It reached 15.9 percent in April 2020 and was still at 11.9 percent in August.
As of December 2021, California still had one of the highest unemployment rates in the nation. Additionally, many states used federal COVID relief money to pay some or all of their unemployment insurance debt, but California has not. One of the reasons employer money hasn't been kept is that California taxes employers only on the first $7,000 a worker earns each year. For example, a company that employs a part-time sanitation worker who earns $8,000 per year and an accountant who earns $100,000 per year would pay the same amount into the unemployment piggy bank for both workers each year. But unemployment benefits cover 50 percent of a worker's salary, up to a limit of $450 per week. The average weekly benefit paid in California in 2021 was less than $320, according to the federal Department of Labor. data. About 28 percent of full-time working Californians earned less than $35,000 in 2019, according to Census Estimates. So if those two workers were laid off and started receiving unemployment benefits, the accountant would receive much larger checks than the sanitation worker.
The $7,000 figure, called the taxable wage base, is "absurd," said Mark Duggan, a Stanford economist who studies unemployment insurance. It's the lowest amount allowed under federal law, only a few other states use it , and it hasn't changed since at least 1984. Since then, the internet has become widely available, mom jeans have gone out of style and made a comeback and, what More importantly, wages and unemployment benefits have increased. Other states have made adjustments. Washington taxes employers on the first $56,500 a worker earns, while Oregon's taxable wage base is $43,800. And it's not just the blue states: North Dakota and Utah have tax bases of more than $38,000. This doesn't mean California employers are necessarily stingy by comparison. In fact, the taxes California employers pay as a share of the total wages workers earn is close to the national average: they are paying a higher tax rate on a lower amount of wages.
But, that configuration has a drawback. If employers end up passing the tax on to employees in the form of reduced wages, hours or fewer jobs, it's a regressive system, Duggan says. Lower-wage workers, especially seasonal, part-time, and student workers, end up subsidizing the cost of higher unemployment benefits for higher-wage workers. A sanitation worker with two part-time jobs paying $8,000 each would have double the money his two employers put into the system compared to the accountant earning $100,000 at his one full-time job.
"Our system works terribly for the most disadvantaged workers in the economy," Duggan said. "It works great for people making six-figure incomes."
This isn't the first time California's unemployment bank has had to turn to the federal government for loans. In the aftermath of the Great Recession, the fund took on about $10 billion in debt and California employers took roughly a decade to get the fund out. Taxpayers ended up paying approximately $1.4 million in bills for interest payments on that loan. In fact, in 2016, when California employers were still paying down debt from the Great Recession, analysts at the nonpartisan Bureau of Legislative Analysis warned that the fund could go back into debt during the next recession.
So what will happen now? To begin reducing debt, federal law will automatically increase federal taxes paid by California employers in 2023 by 0.3 percent, or $21 per employee. The tax will continue to increase an additional $21 per employee each year until the debt is paid off, which could be in the early 2030s assuming there isn't another recession before then. Whether it's a small or large increase depends on where you are.
The looming tax increase for California businesses each year is so small that economists are likely to find it difficult to measure its impact using statistical research methods.
It's a small increase relative to the wages employers are already paying their workers annually, according to an analysis by the California Budget and Policy Center shared with CalMatters. For businesses that pay workers the full-time minimum wage, the tax increase would equate to less than a 5 percent increase in annual payroll costs in 2029, after the tax has been raised for several years. For companies that pay workers more than the minimum wage, the proportional increase would be less. But a coalition of nearly 20 business groups argued in a letter to Newsom last December that the tax increase is large enough to negatively affect hiring for years to come.
Economic research confirms that when the cost of hiring people goes up, employment goes down, said Andrew Johnston, a UC Merced economist who studies unemployment insurance. The usual estimate, he said, is that if labor costs increase by 10 percent, companies will cut employment by about 5 percent. The tax increase coming to California businesses each year is so small that economists will probably find it difficult to measure its impact with statistical research methods, but that doesn't mean it won't have any effect, he said.
Johnston has found that unemployment tax increases of as little as 1 percentage point had a measurable effect on companies that were already cash-strapped when it came to hiring. In other words, barely surviving California businesses are more likely to change their hiring decisions in reaction to a small tax increase. Business groups also noted that many other states used federal COVID relief funds to help pay off their unemployment debt. They cited a large California budget surplus for next year. And they made a request: that the state contribute $10 billion dollars to help pay off the debt.
"This was not a recession created by the business community," said Brooke Armor Spiegel, vice president of the California Business Roundtable, a business group that signed the letter. “This was a recession created by state policies in response to a global pandemic.” Employers are also paying a 15 percent surcharge on their state unemployment tax bill, collected by the state when the unemployment fund goes into disrepair. The surcharge has been in place since 2004 , according to the Legislative Analyst's Office.
Newsom's $3 billion proposal, if approved by lawmakers, would not prevent a tax increase for employers or provide any short-term relief to businesses.
A group of moderate Democrats in the Assembly proposed another amount in February in a letter to the governor : $7.25 million in state dollars to reduce the debt. Newsom proposed spending $1 million in state funds to reduce debt, followed by another $2 million next year in his opening budget proposal, as well as $470 million to pay off interest that will have accrued on the loan by September.
During a state Senate budget hearing in March, Sen. Maria Elena Durazo, a Democrat representing Los Angeles and chair of the subcommittee, asked if the state's low tax base wage contributed to California's high debt. If the state had increased the tax base before the pandemic, it would likely have less debt now, said Chas Alamo of the Legislative Analyst's Office. Newsom's $3 billion proposal, if approved by lawmakers, would not prevent a tax increase for employers or provide any short-term relief to businesses, according to a recent assessment by the Legislative Analyst's Office.
Instead, it would potentially shorten the number of years companies would end up paying higher taxes. The state Department of Finance estimates that $3 billion would shorten the length of the loan by a year, department spokesman HD Palmer said in an email. But that timeline estimate, like many estimates in the budget, can change as factors like the size of California's workforce and the unemployment rate change, Palmer said. If the $3 billion doesn't end up wiping out a full year of the loan period, businesses won't see earlier tax relief, according to Alamo.
"Employers may not see a direct benefit if the pay is too small to reduce the pay schedule by an entire year," Alamo wrote in the analyst's office analysis. If less than a year is eliminated, higher taxes paid by employers beyond what is needed to pay off the loan would be placed in the unemployment fund for future use. The proposed $3 billion would also reduce the amount of interest the state has to pay over the life of the loan, potentially by $550 million to $1.1 billion, according to the Legislative Analyst's Office. The analysis also noted that the debt employers are willing to pay is largely separate from the problem of potentially fraudulent unemployment claims being paid by the state during the pandemic. The vast majority of suspected fraud occurred through temporary federal unemployment programs, which were paid for by the federal government and did not contribute to California's unemployment debt.
“Employers may not see any direct benefit if the payment is too small to reduce the payment schedule by an entire year.” Chas Alamo, Analyst, California Legislative Analyst's Office
Not all business owners share the same level of concern about debt or a looming tax increase. “This is not something we hear from small business owners at all. I mean, not at all,” said Bianca Blomquist, California policy director for the Small Business Majority, which advocates for small business interests. The governor's proposal, he said, felt like a missed opportunity to provide aid to small businesses targeted to their needs, such as helping with business rent or covering the cost of offering additional COVID paid sick days . That's also $3 billion that could be spent elsewhere. Families face high food and gas prices, and have long struggled with high rental costs, Anderson said. "Three billion could help those families a lot," he said.
Is a broader reform needed? The way California funds unemployment benefits manages to be both the least progressive and the most fiscally irresponsible in the nation, according to Duggan's estimate. Duggan, as well as the economists Guo and Johnston, have a proposed solution: Triple the amount of wages subject to tax in California. So policymakers could also lower the tax rate. This would mean that employers of high-wage workers would pay more into the system, which would help offset the higher benefits their workers receive if they are laid off. Employers of low-wage workers would pay less. Done right, it would restore the health of California's unemployment piggy bank, making it less likely to go into debt during future recessions, and less likely the state will end up using taxpayer money to pay big interest.
The Legislative Analyst's Office has also outlined proposals in the past to improve the status of the fund, including increasing the salary tax base to $12,000 and reducing benefits. Fixing how we fund unemployment should have bipartisan appeal, Duggan argues. Those who preach progressive values should agree to fix a regressive system. Those who prioritize fiscal responsibility should want to reform the policy that puts California in debt. But, then there's how real politics works. This theme is not "not very pretty," to use Duggan's phrase. It's hard to explain and even harder to campaign. And although his proposal is a tax redistribution, anyone who defends it could be labeled a tax collector. "It's frustrating when you study economic policy to see really retrogressive policies persist," Duggan said, "because of the nature of the political process."
This article was originally published by CalMatters .
