A Hidden Budget Deficit: The Unemployment Insurance Fund

Largely overlooked among the angst and rhetoric over the general fund’s stark $21 billion budget gap is the fast-growing deficit in the state’s insolvent Unemployment Insurance Trust Fund.

In an October fund forecast, the state Employment Development Department predicted the fund would end the 2009 calendar year $7.4 billion in the hole. In 2010 that deficit would more than double to $18.4 billion and hit $27.2 billion the following year, if no changes in the fund’s financing structure are made.

There are only three things that can be done to restore the fund to solvency – increase employer contributions, cut benefits or some combination of both.

The fund’s insolvency will eventually have an impact on the state budget because California has turned to the federal government for over some $4 billion in loans in order to keep paying unemployment benefits, the volume of which has increased as the state’s unemployment rate climbed to 12.5 percent in October.

Federal loans lasting more than one year carry interest charges of 5 percent per year on the outstanding balance.

The state began borrowing in January 2009 but part of the federal economic stimulus package waives interest owed on borrowed fund for 2009 and 2010.

Interest will be charged starting in January 2011 and repayment of the interest no later than September 30, 2011. The department estimates that amount to be $730 million

This is the second time in five years the fund has faced insolvency. The state predicted the fund would go into the red early in 2004 but a boost in the economy and employment made the fund solvent again.

At the time, the Legislative Analyst warned, “another recession could easily send the fund back into insolvency.”

In it’s forecast last year, the Employment Development Department predicted the fund would be $2.4 billion in the red by the end of 2009 and $4.9 billion in the red by the end of 2010.

But those predictions were premised on California’s unemployment rate being 6.6 percent last year, 6.7 percent this year and 6.5 percent in 2010.

Employer contributions on behalf of their employees create the fund. There are eight contribution rates, the lowest being AA that, in theory, would be the level employers pay when the fund is flush. When the fund is heading toward insolvency or is already in the hole, the highest schedule, F+, is used which is 6.2 percent.

Employers are also paying an additional 15 percent surcharge required by law when the fund’s balance dips below a certain level.

In part, the rate an employer pays is based on the “experience rating’ of his employees – how often they have collected unemployment insurance in the past.

Even in relatively good times, contribution rates have not fallen below C. In part, that’s because employers pay their unemployment tax based on the first $7,000 in wages paid to each worker – a wage ceiling dating back to 1983. The maximum paid is $434 per employee each year. So even in a stable economy, the base is too low to cover demand.

Like the rest of the state budget, the unemployment insurance fund has major systemic problems. The $7,000 wage maximum is one of them.

Another is 2001 legislation that increased the maximum weekly benefit from $220 to $450 over a four-year period. That increase was one of the reasons for the fund’s 2004 insolvency issues.

However, the legislation did not increase the $7,000 ceiling or the rate so the same amount of money was supposed to cover roughly doubled benefits.

California’s $450 weekly maximum is slightly higher than the $409-a-week national average.

In November 2008, Gov. Arnold Schwarzenegger offered a plan to restore the fund’s fiscal health. Schwarzenegger proposed increasing the taxable wage ceiling from $7,000 to $10,500. Forty-two states tax more than the first $7,000.

The governor also proposed to increase the maximum tax rate from 6.2 percent to 8.1 percent.  The higher wage ceiling would generate $2.7 billion. The higher tax rate, another $1.4 billion.

Schwarzenegger estimated the per-employee payment increases to range from $56 to $427 – depending on the employee’s experience rating.

The governor’s proposal would have increased the maximum tax per employee from $434 to $851. The national average is $995.

To save $300 million, eligibility would have been made slightly harder by the governor – a claimant would need to work 7.5 weeks per year rather than the current 3.5.

Employers weren’t thrilled at the prospect of having their contributions increase by $4.1 billion in 2010. They argued, to a certain extent rightly, that it’s not helpful to the economy to jack up taxes at the height of a recession.

The massive budget shortfall, opposition from employers and employee groups who didn’t want to see eligibility curtailed ensured the plan went nowhere.

Two pieces of legislation introduced by Democrats also went nowhere. No new proposal to restore solvency has surfaced.

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