UNEMPLOYMENT INSURANCE : Financing of Benefits

Prior to the passage of the Social Security Act in 1935, relatively few employees had any type of protection for income lost during periods of unemployment. The act stipulated that a payroll tax was to be levied on covered employers for the purpose of financing unemployment insurance programs that were to be established by the states under guidelines issued by the federal government. Essentially, the federal law levied a federal tax on certain employers in all states. If a state established an acceptable program of unemployment insurance, the state taxes used to finance its program could be offset against up to 90 percent of the federal tax. If a state failed to establish a program, the federal tax would still be levied, but no monies collected from the employers in that state would be returned for purposes of providing benefits to the unemployed there. Needless to say, all states quickly established unemployment insurance programs. These programs (along with a federal program for railroad workers) now cover more than 95 percent of all working persons, but major gaps in coverage exist for domestic workers, agricultural workers, and the self-employed.

There are several objectives of the current unemployment insurance program. The primary objective is to provide periodic cash income to workers during periods of involuntary unemployment. Benefits are generally paid as a matter of right, with no demonstration of need required. While federal legislation has extended benefits during times of high unemployment, the unemployment insurance program is basically designed for workers whose periods of unemployment are short-term; the long-term and hard-core unemployed must rely on other measures, such as public assistance and job-retraining programs, when unemployment insurance benefits are exhausted.

A second major objective of unemployment insurance is to help the unemployed find jobs. Workers must register at local unemployment offices, and unemployment benefits are received through these offices. Another important objective is to encourage employers to stabilize employment. As will be described later, this is accomplished through the use of experience rating in determining an employer's tax rate. Finally, unemployment insurance contributes to a stable labor supply by providing benefits so that skilled and experienced workers are not forced to seek other jobs during short-term layoffs and thereby remain available to return to work when called back.

Financing of Benefits
Unemployment insurance programs are financed primarily by unemployment taxes levied by both the federal and state governments. The federal tax is equal to 6.2 percent of the first $7,000 of wages for each worker, but this tax is reduced by up to 5.4 percentage points for taxes paid to state programs. The practical effect of this offset is that the federal tax is actually equal to .8 percent of covered payroll. A few states levy an unemployment payroll tax equal to only the maximum offset (5.4 percent on the first $7,000 of wages), but most states have a higher tax rate and/or levy their tax on a higher amount of earnings.

No state levies the same tax on all employers. Rather, states use a method of experience rating whereby all employers, except those in business for a short time or those with a small number of employees, pay a tax rate that reflects their actual experience, within limits. Thus, an employer who has laid off a large percentage of employees will have a higher tax rate than an employer whose employment record has been stable.

An employer with "good experience" will often pay a state tax of less than 1 percent of payroll and possibly as little as .1 percent. Other employers may pay a state tax as high as 9 percent or 10 percent. Regardless of the actual state tax paid, the employer will still pay the .8 percent federal tax.

The major argument for experience rating is that it provides a financial incentive for employers to stabilize employment. Those opposed to its use contend that many employers have little control over economic trends that affect employment. In addition, they argue that tax rates tend to rise in bad economic times and, in so doing, may actually thwart economic recovery.

The entire unemployment insurance tax is collected by individual states and deposited in the Federal Unemployment Insurance Trust Fund, which is administered by the secretary of the treasury. Each state has a separate account that is credited with its taxes and its share of investment earnings on assets in the fund. Unemployment benefits in the state are paid from this account. The federal share of the taxes received by the fund is deposited into separate accounts and is used for administering the federal portion of the program and for giving grants to the states to administer their individual programs. In addition, the federal funds are available for loans to states whose accounts have been depleted during times of high unemployment.