Strong and equitable unemployment insurance systems require broadening the UI tax base
The COVID-19 pandemic showed how critical unemployment insurance (UI) is for sustaining workers and the economy during times of crisis, while also revealing deep fissures and inequities in UI systems. Federal programs that expanded UI eligibility, benefit levels, and benefit duration kept local economies afloat and became a lifeline for millions during the early stages of the pandemic, but the crush of UI claims at peak levels of unemployment also exposed the poor condition of state UI systems. From backlogs and delays caused by insufficient administrative capacity and outdated technology to inadequate benefit amounts, many state UI systems operate in a chronic state of underfunding that results in inequity and dysfunction.
One of the root causes of these problems is rarely discussed: Lawmakers have structured state UI financing in a way that permanently starves the UI system. UI is currently funded through a combination of federal and state taxes paid by employers, where state UI taxes pay for benefits during normal economic times. However, in most states, the amount of employee wages on which employers pay state UI taxes, i.e., the taxable wage base (TWB), is extremely low. At present, 14 states and Washington, D.C. have taxable wage bases below $10,000 and a remarkable 36 states have their bases set below $25,000. This means that in 71% of states, employers pay UI taxes at most on the first $25,000 of an employee’s annual earnings.
These taxable wage base rates have proven insufficient to sustain UI systems during periods of low unemployment, and especially during times of economic crisis like those encountered during the recent pandemic. UI benefits on average replace about 40% of workers’ pre-layoff wages, but the share of all wages that are subject to UI taxation has declined from 98% in 1938 to 25% in 2019. Most states’ UI taxation rates fall short of financing even these meager benefit levels, which are so low there is nowhere in the country where they are sufficient to meet workers’ basic needs. The result is chronic insolvency of many states’ UI trust funds, and vulnerability to insolvency during times of crisis for many more. In fact, according to the Department of Labor, only eight states had an average UI tax rate in 2021 that was above the minimum financing rate adequate to cover states’ benefit payments.
Short of much-needed comprehensive federal UI reform, increasing the taxable wage base is a key step states can undertake to make the UI system more equitable and sustainable. All states can, and should, increase their taxable wage bases to half of the Social Security tax wage base limit, which is $147,000 for 2022. Increasing the taxable wage base would apply UI taxes more evenly across employers, improve the overall solvency of state UI systems, secure funding to improve administration of UI benefits, and allow for critically needed expansions and modernization of UI systems to ensure adequate and equitable access to benefits.
This is a timely reform for states to consider precisely because many are currently trying to resolve financial shortfalls that have arisen from the unprecedented number of UI claims caused by the pandemic, in addition to decades of underfunding. Yet even before COVID-19 struck, many states failed to determine workers’ eligibility, pay benefits, or decide administrative appeals in a timely manner, leaving laid-off workers to languish in extensive backlogs and delays. When UI systems fail, millions of working people can be left struggling to just survive or may be forced to take work that is underpaid, unsafe, unstable, or a poor match for their skills.
Federal relief measures, including the Coronavirus Aid, Relief, and Economic Security (CARES) Act, Families First Coronavirus Response Act (FFCRA), and American Rescue Plan Act (ARPA), have allocated significant funds for states to support UI systems administration, prevent fraud, and increase access and equity. Addressing low taxable wage bases is equally essential for states to ensure that these federal investments are accompanied by structural improvements to state UI financing.
Increasing state UI taxable wage bases is also a much more effective long-term solution to shoring up state UI trust funds than the stop-gap measure some states have pursued by using one-time relief funds to replenish UI trust funds, thereby creating an implicit tax cut for employers and continuing systemic underfunding. Coupling the recent infusion of federal funds for improving UI with long-overdue increases to state taxable wage bases could, however, lead to transformative, lasting improvements.
Overview of current UI financing system
UI is funded by a combination of state and federal taxes levied on most employers, in which employers pay a federal UI tax authorized by the Federal Unemployment Tax Act (FUTA) and a state unemployment tax (SUTA) as determined by individual state law. Federal funding goes toward administrative costs while SUTA collection finances benefits paid out to UI recipients during “normal” economic times, and additional federal funds also kick in to support some extended UI benefits during periods of economic downturn.
The FUTA tax rate is 6.0% on the first $7,000 of wages each employee is paid, i.e., the TWB for federal UI taxes. However, employers are offered a tax reduction of up to 5.4 percentage points off the FUTA rate if they are in states that meet a set of conditions set by the federal government. This means that some employers pay a meager $42 per year per employee in FUTA taxes. FUTA revenue to the states generally covers administrative costs and a portion of extended UI benefits during downturns. This level of funding at the federal level is one of the primary sources of fiscal constriction of the UI system and inadequate funding for UI administration, resulting in major problems such as outdated computer systems and understaffed agencies.
UI benefits paid out to workers during normal economic times are based on SUTA collection. The TWB and tax rates for SUTA taxes differ greatly across states. SUTA tax rates can differ widely from employer to employer even within the same state because of the specifics of the complex “experience rating” method used to determine employer SUTA rates. These rating methods assign different tax rates to different employers based on some measure of an employer’s “experience with unemployment.”
Figure A details the TWB across the 50 U.S. states and Washington, D.C., according to the 2021 comparison of state unemployment laws report published by the Department of Labor. Fourteen states and D.C. have taxable wage bases below $10,000 and a remarkable 36 states have their bases set below $25,000. Washington state has the highest TWB of $52,700 and several states have the lowest TWB of $7,000. This SUTA TWB low of $7,000 is the floor precisely because having a state TWB no lower than the FUTA TWB is one of the conditions for employers to qualify for the FUTA credit, and states generally ensure that employers in their state can qualify for the FUTA credit.
Inadequate taxable wage bases undermine the financing of state UI programs: Taxable wage bases across the 50 U.S. states and D.C.
|State||Taxable Wage Base|
Woefully inadequate and inequitable funding for state UI systems harms both workers and some employers
These widely varying, yet consistently inadequate, financing systems for state UI programs—rooted in low taxable wage bases—create serious problems and magnify inequities for both workers and employers. This results in employers of low-wage workers paying a higher share of their employees’ wages in UI taxes. For example, the employer of a worker in New York who earns $10,000 a year pays SUTA taxes on 100% of that worker’s wages. However, the employer of a worker in New York making $50,000 a year pays SUTA taxes on just 24% of that worker’s wages. This creates a vicious cycle, most notably for low-wage workers, as employers try to pass on UI taxes to workers by lowering workers’ wages even further.
In addition, UI benefits are based on a much higher share of wages for many workers relative to the share on which their employer pays UI taxes, creating conditions for possible solvency issues. For example, let’s return to the previous scenario of two workers in New York, one making $10,000 and the other $50,000. Both workers will have all their wages considered in calculating their benefit level if they were to file for UI even though the employer of the worker making $50,000 paid SUTA on just the first $11,800 of her earnings.
State lawmakers can make their state’s UI financing stronger, better for workers, and fairer for employers
State legislatures have the power to make robust improvements to UI financing and the UI system simply by increasing UI taxable wage bases. One simple yet powerful fix would be to increase their taxable wage bases to half of the Social Security tax wage base limit under the Federal Insurance Contributions Act (FICA), which is $147,000 for 2022. This benchmarking is attractive for several reasons. First, the social security limit is indexed to wage growth and is therefore automatically adjusted annually to align with rising wage levels. For years, the FUTA base limit, which is the lowest TWB across states, was very close to the Social Security limit. The Social Security tax limit was indexed to wage growth in 1977. However, in the absence of regularly being adjusted, the real value of the UI TWB has eroded by nearly 800% and has diverged sharply from the Social Security limit. Raising the base to half of the Social Security tax wage base would not entirely erase this erosion, but it would be a huge step toward a more secure UI financing system. Across the United States, an estimated 72% of full-time, year-round workers earned below $75,000 in 2020. Figure B shows the comparable state-level figures for this, suggesting that most workers will have most or all their wages covered under the proposed taxable wage base.
Furthermore, a higher TWB can be a key to securing better funding for UI and thereby creating and maintaining an equitable UI system that serves workers. As previously noted, regular federal funding to states for UI administration based on FUTA collection has historically been insufficient. The extraordinary problems experienced with administering UI at the start of the pandemic were not inevitable but rather the result of decades of inadequate funding and neglect. Federal relief funds recently designated for UI modernization are providing opportunities to take first steps toward addressing these problems, and increased revenue from increasing state TWB will be necessary to sustain critical systems improvements over time.
Increased state revenue collection could be used to ensure workers receive adequate benefit levels, modernize technologies used by states, and hire enough staff to administer benefits. To achieve a truly equitable UI system, a sufficient workforce is also necessary for public communication and outreach to ensure that workers who qualify for UI know about and can access their benefits. This is especially critical for low-wage workers who likely are most dependent on benefits to make ends meet, particularly during crises like the current pandemic.
A taxable wage base half of the Social Security base will make UI more equitable and effective: Share of full-time, year-round workers with earnings below $75,000
|State||Share of workers with earnings below $75,000|
Note: The Social Security tax wage base under the Federal Insurance Contributions Act (FICA) is $147,000 for 2022 and is updated annually to account for wage growth.
Source: Author calculations using data from U.S. Census Bureau, Earnings in the Past 12 Months (in 2020 Inflation-Adjusted Dollars), based on the 2020 American Community Survey (ACS) 5-Year Estimates.
Fixing state UI financing is a crucial part of leveraging federal relief funds to achieve structural UI reform
State taxable wage bases have been far too low for too long, and the result has been a dysfunctional UI system. Now is the time for states to apply lessons learned from the pandemic by increasing the TWB to address underfunding for the long term, while leveraging temporarily available federal relief funding to make investments in administration, technology, outreach, and communications systems upgrades that improve access and equity. For example, ARPA State and Local Fiscal Recovery Funds (SLFRF) can be used to improve UI systems. Guidance from the U.S. Treasury Department explicitly encourages states to use SLFRF funds to address racial and economic inequities and to support “a strong, inclusive, and equitable recovery, especially uses with long-term benefits for health and economic outcomes.” ARPA also allocated $2 billion to the U.S. Department of Labor to improve unemployment insurance systems, funding grants to states for fraud prevention, equity initiatives, and expert state systems assessment and assistance. Ensuring this infusion of federal relief funds helps achieve intended long-term goals for strengthening UI systems and equity will simultaneously require state fiscal policy reforms, including increasing the taxable wage base in most states.
While there is ample role for the federal government to play in increasing UI taxable wage bases for FUTA taxes, state lawmakers can and should also increase the TWB on which SUTA taxes are based. Doing so will make it feasible to finance structural reforms necessary to make the UI system both more equitable and a more powerful macroeconomic stabilizer. Increasing the taxable wage base can also help state lawmakers resist pressure to squander federal relief and recovery funds to backfill depleted UI trust funds. Without broadening the tax base for their UI systems, many states will continue to face daunting solvency issues with every economic downturn. State lawmakers should reform these systems now so they can be confident that workers, employers, and their state’s economies will be protected when the next recession hits.
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