Feature: Unemployment Trust Fund Solvency Revisited

by John Berglund - john.berglund@state.mn.us
October 2009

Part one of this article, published in the January 2009 issue of Minnesota Employment Review, presented an overview of solvency issues facing the Unemployment Insurance (UI) Trust Fund in the U.S. Treasury. The UI Trust Fund is a series of accounts for each state and territory of the U.S., so the balance of the federal UI Trust Fund equals the sum of the balances of the 53 separate jurisdictions’ accounts. This article explores further developments in the UI Trust Fund and state balances with a focus on Minnesota.

The National Bureau of Economic Research identified December 2007 as the start of the current recession. The recession has taken a great toll on the UI Trust Fund and individual state balances. At the end of December 2007 the balance in the federal UI Trust Fund was $38.3 billion; by the end of 2008 it had shrunk to $30 billion. Minnesota’s UI Trust Fund was $529.2 million at the end of 2007 and slid to $496.1 million at the end of 2008.

At the end of 2007 only Michigan was in UI debtor status for $134.6 million. By the end of 2008 Michigan was joined by South Carolina and Indiana. Collectively, these states had borrowed $941.6 million from the Federal Unemployment Account (FUA). FUA is funded by a portion of the Federal Unemployment Tax Act (FUTA) levies on employers and serves as a revolving loan fund from which states may borrow when their trust funds are depleted.

The first calendar quarter of 2009 brought an additional group of debtor states into the mix. New York and Ohio borrowed in January, followed by California, Kentucky, Missouri, North Carolina, and Wisconsin in February. Arkansas, New Jersey, Pennsylvania, and Rhode Island entered debtor status in March. By the end of March the combined debt total had risen to $7.56 billion.

The timing of ongoing UI benefit payments and tax receipts were factors in the debt increase to $9.96 billion at the end of April 2009. By the end of May partial loan repayments by some states had reduced the outstanding loan debt to $8.57 billion. Only Idaho joined the debtor fold in June, but the debt rose from $8.57 billion to $10.23 billion at the end of June. In July Illinois joined the debtor ranks; cumulative debt among the states rose to $12.7 billion.

Minnesota joined Florida, South Dakota, and Texas in moving to the ranks of debtors in August. The loan balance rose to $13.58 billion at the end of August. By the end of September, Arkansas and the Virgin Islands had joined the debtors’ group. As of September 15, 2009, the outstanding FUA loans had grown to $15.23 billion.

What factors set these borrowing states apart? One factor that some of these states share, particularly the first ones to join the ranks of debtor states, is their high concentration in automobile and auto parts manufacturing. Michigan, Wisconsin, Illinois, Indiana, Ohio, and Pennsylvania have been heavily involved in durable-goods manufacturing. The collapse of the auto industry hurt these states’ economies, straining and depleting their UI Trust Funds as more and more workers lost their jobs. We can also include Missouri, California, and Kentucky in the automobile and automobile parts manufacturing victims’ category.

Beyond industry mix, however, there were other important signs that resources and replenishment capability were inadequate to the task. In Table 1 the six states in bold have not raised their tax bases since the federal tax base was increased to $7,000 in 1983. Four of the six states, California, Florida, Indiana, and South Carolina, retained the same $7,000 tax base in 2008 that they had in 1983. The tax base in Alabama and Kentucky was $8,000 in 2008, the same as they had in 1983.

An additional eight states (see the states highlighted in grey inTable 1) increased their UI tax bases by up to $2,500 between 1983 and 2008. Michigan and Pennsylvania each increased their tax bases by $1,000 (Michigan to $9,000; Pennsylvania to $8,000); New York raised its tax base $1,500 to $8,500 between 1983 and 2008. Ohio, South Dakota, and Texas raised their tax base $2,000 from $7,000. Arkansas and Wisconsin each raised their base, to $10,000 and $10,500 respectively. The remaining eight states have to varying degrees raised their tax base in line with increases in their average weekly wage rate.In 1983 most states had tax bases that were at least at 40 percent of their average annual wage (AAW), but of the 22 that are currently in loan status, California, Michigan, New York, Ohio, and Texas had tax bases under 40 percent of AAW at that time.

Fast forward to September 2009: four of these same five states had the highest outstanding loans (see Table 1). Further, their tax bases are less than 25 percent of their average annual wages. Texas is the exception among these five states by not being near the top of the debtor list.Some states in UI loan status did not appreciably increase their tax bases between 1983 and 2008. They did, however, manage to keep nearly the same proportion of maximum weekly benefit amount (MWBA) to average weekly wage (AWW). This MWBA/AWW ratio would be the wage replacement ratio, an effort to mitigate the unemployed workers’ loss of wages.

Note California, Indiana, Michigan, and South Carolina in Table 2. California, Indiana, and South Carolina have kept their taxable wage bases at the same level as the federal tax base since 1983. Their ratios of tax base to average annual wage have dropped by more than half (see Table 1), indicating an erosion of taxing effort. But from Table 2 we can see that these states maintain a fairly constant wage replacement by tying their maximum weekly benefit amounts more closely to their average weekly wages.

Michigan, which raised its taxable wage base from $8,000 to $9,000 over the 26 years, has recently been replacing lost wages at a lower rate than earlier. It is worth noting here that California and Michigan, the states with the greatest indebtedness as of September 15, 2009, have MWBAs that are less than half their respective AWWs. The examples of these four states and others in Table 2 that increased benefits to keep pace with inflation but did not expand their taxing effort should raise caution flags among states that are interested in raising benefits in line with inflation.

If a state raises benefits and wishes to balance that action to maintain solvency, it can do so by increasing its revenue stream. While this is not a novel concept, “the devil is in the detail.” Does a state raise the employer tax base, change the tax tables so that the levies produce the newly needed amounts, impose surcharges or solvency taxes, combine all of these, or create another option?

A low tax base is not necessarily the sole cause of a state being in debt. At the start of a downturn, the available balance in a state’s trust fund, the responsiveness of a state’s tax system to replenish drawdowns, tax base increases, solvency assessments or surcharges, and diversity in industry and employment mix may all be factors.

Minnesota is a good example (see Table 2). Minnesota has a comparatively high tax base, a very progressive and broad experience rating system (the system by which an employer’s UI tax rate is determined based on their previous use of UI), and a high maximum weekly benefit amount, so our replacement ratio is high. However, even under these conditions, the recession has taken its toll. While our auto and auto parts manufacturing sector is not nearly as important as for the rest of the Great Lakes states, our manufacturing sector overall has experienced substantial losses. Our construction, financial, real estate, and retail trade sectors have mirrored what has happened at the national level, suffering much the same rates of closure, downsizing, and layoff.

The ongoing slump has made demands on Minnesota’s UI benefit and tax systems that have been greater than our ability to fund those demands. We started 2008 with $592 million in our UI Trust Fund; we ended 2008 with $496 million in the fund. By September 15, 2009, we had borrowed $27 million. We went through the $496 million in the fund, an additional $130 million in American Reinvestment and Recovery Act funds, $566 million in Minnesota deposits through July, and an estimated $69 million for August and into September. That means that we have paid out about $1.3 billion in regular UI benefits through mid-September. While Minnesota’s situation is not unique, it is a quick example of how economic conditions can overwhelm a system before it can respond. The UI Trust Fund balance at the start of a downturn, the responsiveness and elasticity of the tax system and the taxable wage base on which taxes are levied all affect whether or not a state remains solvent or goes into debt when mired in a recession of this severity. But this recession has overwhelmed even relatively good planning and policy measures.