Tapping the Feds

By John Berglund
March 2010

PDF of article

Minnesota is among 25 states and one territory that have been forced to borrow $26.5 billion from the federal government because their unemployment insurance trust funds ran out of money.

The U.S. recession that began in December 2007 has taken a toll on the federal Unemployment Insurance (UI) Trust Fund. At the beginning of the recession, the federal fund—essentially the total UI funding contained in the accounts of 53 states and territories—had a balance of $38.3 billion.

The federal fund had shrunk to $30 billion by the end of 2008 and was down to $14.2 billion by Sept. 30, 2009.

About half the states depleted their UI funds and have been forced to borrow $26.5 billion from the federal government since December 2008 in an attempt to keep abreast of rising unemployment benefits.

Going Into Debt

Michigan was the first state to run into trouble, borrowing $134.6 million for its fund by the end of 2007. South Carolina and Indiana followed in 2008 when they borrowed a total of $941.6 million from the Federal Unemployment Account, which is a revolving loan fund for states that have run out of UI funding.

A flood of states entered the mix in the first quarter last year— New York and Ohio in January; California, Kentucky, Missouri, North Carolina and Wisconsin in February; and Arkansas, New Jersey, Pennsylvania and Rhode Island in March.

By the end of last March, states had borrowed a total of $7.6 billion from the federal government to replenish their funds.

As the year progressed, still more states had to borrow from the fund, including Idaho in June and Illinois in July. Minnesota joined the ranks of borrowers in August along with Florida, South Dakota and Texas. Alabama and the Virgin Islands came next in September, followed by Connecticut, Nevada and Virginia in October.

Georgia became the 26th debtor in December, bringing the total amount borrowed from the Federal Unemployment Account to $26.5 billion.

One obvious question is why were these states forced to borrow while others weren’t? The collapse of the auto industry was one factor. Some of the first states to borrow from the fund— Michigan, Wisconsin, Illinois, Indiana, Ohio and Pennsylvania— have a high concentration of automobile and auto-parts manufacturers. Missouri, California and Kentucky also fall into that category.

Another factor, though, was the failure of states to increase their UI tax bases since the federal tax base increased to $7,000 in 1983. The tax base is the amount of wages to be taxed. Each employer must pay UI taxes on the wages of each employee up to the federal base level. States can choose, however, to set their tax bases higher than the federal rate.

As Table 1 (pdf) illustrates, many state governments have failed to increase their UI tax bases despite growing wages and benefit liabilities during the past quarter century. They include California, Florida, Indiana and South Carolina. Tax bases in Alabama and Kentucky were $8,000 in 1983 and haven’t been changed since.

Ten other states increased their UI tax bases by $2,500 or less between 1983 and 2008—Arkansas, Georgia, Michigan, New York, Ohio, Pennsylvania, South Dakota, Texas, Virginia and Wisconsin. These states have tax bases in the $8,000 to $10,500 range.

But other states that had to borrow, including Minnesota, have raised their tax bases in line with increasing annual wages. Minnesota’s UI tax base, for example, was $25,000 in 2008.

In 1983 most states had tax bases that were at least 40 percent of their average annual wage.  Of the 26 that are currently in loan status, however, only six have tax bases that are at least 40 percent of their average annual wage: Idaho, Minnesota, Nevada, New Jersey, North Carolina and the Virgin Islands.

Along with UI tax revenue, the other factor in UI account balances is how much states pay in benefits.

Five of the debtors have raised UI benefits significantly, so that in 2008 the ratio of the maximum weekly benefit to the average annual wage was at least 10 percent higher than it was in 1983. They are Arkansas, Indiana, Kentucky, Rhode Island and the Virgin Islands. The Virgin Islands was the only one of these five to raise its UI taxable wage base by more than $5,000 over the 25-year period, increasing it from $8,000 to $21,800.

A low tax base isn’t the only reason that a state might deplete its UI trust fund. Entering a recession, the following also could be factors:

• The available balance in a state’s trust fund.
• The responsiveness of a state’s tax system to replenish draw downs through tax rate increases, tax base increases, and solvency assessments or surcharges.
• Diversity in industries and employment.
  

Where Does Minnesota Stand?

Minnesota is a good example of the impact of the Great Recession. The state has a relatively high tax base, progressive policies and a high maximum weekly benefit amount. Still, even under these conditions, the recession has taken its toll.

While the auto and auto-parts manufacturing sector isn’t as important in Minnesota as elsewhere in the Great Lakes region, the state’s manufacturing sector experienced substantial losses. The construction, financial, real estate and retail sectors also have mirrored the country as a whole, experiencing closures and layoffs. 

The state’s UI Trust Fund entered 2008 with a balance of $592 million and ended the year at $496 million. By the end of 2009, the state had been forced to borrow $281 million to replenish the fund. Altogether, the state paid out $2.8 billion to 350,000 unemployed Minnesotans last year.

While Minnesota’s situation is not unique, it is a good example of how economic conditions can overwhelm a system before it can respond. Trust fund balances at the start of a downturn, the responsiveness and elasticity of the tax system, and the taxable wage base can affect whether a state’s trust fund remains solvent during a recession.

But as this recession has shown, even relatively good planning and policy measures sometimes are not enough.   

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