How Unemployment Insurance Works

Cameron Hamilton

Unemployment systems are not designed to withstand a year like 2020

  • Unemployment claims this year are 10x higher than previous highs
  • Unemployment insurance funds are being depleted at the state level
  • Business owners will likely pay the shortfall in future years without reform

The all-time chart of unemployment claims will need to be remade after 2020; it will be simply unreadable.  Weekly claims have never been higher than 700,000 in the worst of prior recessions, but came close to 7,000,000 in March.  Just like the chart, we’re learning that unemployment systems are not designed to withstand a year like 2020.

How Unemployment Functions Normally

Unemployment insurance in the US was born after the Great Depression and is administered at the state level, meaning there are 53* systems with their own rules, rates, and administrations.  Employers pay unemployment tax based on a percentage of wages for each employee, 6% on the first $7,000 of earnings at the federal level.  This can be reduced to 0.6% in states that levy their own unemployment tax.  At the state level, each employer pays a rate based on the conditions in that state and their company’s claims experience.  If a business has many employees claim unemployment benefits, they will likely pay a higher rate in the future**.

Using Kentucky as an example, the state UI trust fund ended 2019 with a $618 Million balance.  It took in $363M from employers and paid out $271M to unemployed workers.  State-level trust funds generally move with economic cycles; funds accumulate during expansions and are depleted during recessions.  After the Great Recession and a period of high claims, KY borrowed $972M from the Federal government, which it paid off thru increased employer contributions thru 2015.

Unemployment in 2020

This normal ebb and flow of unemployment trust funds has been hit with a tsunami of simultaneous unemployment that is 10x the worst periods in history.  In addition to the historic rise in claims, programs have been expanded at state and federal levels.  Most states expanded coverage to self-employed and independent contractors, covering workers like solo business owners, gig economy workers, and part-time workers.  Federally, benefits were expanded in the CARES Act with an additional $600/week thru July, which may be continued in some form with a second wave of legislation.

Again using Kentucky, the state trust fund has been depleted and in June the state took out a Federal loan for $825M.  Kentuckians have received over $3.2 Billion to date this year and it seems likely that both numbers will balloon in the second half of the year.

Implications for States & Employers

This is a truly awful double whammy for states; revenues will be much lower thanks to decreased payroll tax revenue at the same time expenses have skyrocketed.  Even the best-off states ran only small surpluses in 2019.  The deficits that will likely be accumulated this year could need to be paid for over a long period.  KY businesses paid elevated unemployment tax for eight years following the Great Recession, 0.7-1.0% higher in 2009 compared to 2019.  Without relief of these Federal loans, businesses should expect their states to increase rates for all, with bigger hits for employers who had to eliminate employees.

The financing of unemployment systems is a microcosm of larger state budgets, which will be stressed like never before after this extremely sharp recession.  To even begin discussing the knock-on effects of this squeeze would take much more space than I have in this commentary.

Notes for Individuals

If you or a loved one are unemployed or experiencing a decrease in income, there are two notes we would like to highlight.  First, benefits have been expanded to many classes of workers who were not previously eligible.  Even if you are not a full-time, W2 employee, you may be eligible for state and federal benefits.  Second, although the particulars vary by state, unemployment benefits ARE taxable.  Those receiving benefits and not withholding tax this year are likely to be surprised with a tax bill next spring.  I fear that a great majority of the workers receiving expanded benefits don’t have experience managing withholdings or making estimated tax payments.  It is prudent for them to estimate their withholdings by working with a tax professional or using the IRS withholding estimator at https://www.irs.gov/individuals/tax-withholding-estimator.

 

*Each state, plus DC, Puerto Rico, and the US Virgin Islands

**States verify claims with employers; employers can appeal in cases of misconduct firing and voluntary resignation

 

SOURCE:

Unemployment Claims Chart via Federal Reserve Bank of St. Louis. https://fred.stlouisfed.org/series/ICSA

 

“Kentucky unemployment insurance fund has a balance of $0”. Kentucky Chamber.

https://kychamberbottomline.com/2020/07/23/kentucky-unemployment-insurance-fund-has-a-balance-of-0/

KY UI Trust Fund 2019 Annual Report https://kcc.ky.gov/Documents/2019%20Trust%20Fund%20Annual%20Report.pdf

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