Briefing Report: Addressing California's Unemployment Insurance Insolvency

A Status Update
Tuesday, August 13, 2013

Introduction

With less than five weeks left in this legislative session, some indicators suggest the possibility of a legislative reform proposal being introduced by Governor Brown’s Administration that would bring California’s Unemployment Insurance (UI) Trust Fund (Fund) out of insolvency.1

UI insolvency is not a new issue.  The Fund has been insolvent since 2009. Since then, several reform proposals intended to bring solvency to the Fund have been circulated. These proposals did not receive serious consideration by policy makers because they included tax increases. 2 Additionally, some policy makers and stakeholders were holding out hope that the federal government might in some way bail out the states with large UI debts. Obviously, Democrats now have a 2/3rd super majority in the Senate and are currently one vote shy of a super majority in the Assembly and thus can pass a UI Tax increase without needing much help from Republicans.  Additionally, hope for some form of federal bail-out or other financial help has completely faded.

In anticipation of likely Brown Administration backed legislation, intended to bring solvency to California’s UI Fund, this briefing report discusses the status of the UI Fund, how the Fund became insolvent, various reform proposals for bringing solvency to the Fund, the perspective of stakeholders, and economic reforms outside of the UI system that policy makers may want to consider.

Status and Impact of Insolvency

The UI Fund is currently $10.2 billion in the red.  This is money owed to the federal government.  Since 2011, California has paid $611.6 million in interest, which was borrowed from the State Disability Insurance Fund.3   California is scheduled to make an estimated $291 million in interest payments in 2013. Each year that the fund is insolvent, employers lose .03% of their Federal Unemployment Tax Act (FUTA) offset credit.4 03% amounts to a $21 payroll tax increase per employee per year.5 The reduction of the offset credit in 2012 cost California employers $290 million, and is expected to cost $308.2 million in 2013. If the fund remains insolvent through 2019, the reduction in offset credits in 2019 is expected to amount to over $2.5 billion. The Employment Development Department (EDD) estimates that, if nothing is done to address the insolvency issue, the UI Fund will be back in the black by 2020, assuming an unemployment rate declining to 7.9%.6

It is important to remember that as long as California’s UI Fund remains insolvent, between 2013 and 2020, California will continue to pay annual interest on the borrowed UI Fund money and employers will continue to lose their FUTA offset credit (losing this credit would essentially mean a total increase in per employee UI taxes to $231 per year).

How We Got Here

The current imbalance in the UI Fund can be attributed to basically two things.7 In 2002, during the Davis Administration, Republicans, the Legislative Analyst’s Office (LAO) and EDD, warned that increases in benefits without corresponding taxes and cost reducing reforms, would lead to insolvency.  Those warnings went unheeded and the Democrats enacted significant increases to benefits.    Second, a particularly bad business climate, by years of over-regulation, combined with the national economic crisis, set the stage for the high unemployment that followed.

The Proposal

Although no specific proposal has been put into legislation yet, the Administration is circulating a proposal among stakeholders that is rumored to increase the taxable wage base on each employee from $7,000 to $12,000 by 2015 with a goal of solvency by 2016 and an $11 billion surplus by 2021. This is similar to one of two reform scenarios circulated by the Administration earlier this year. Like the proposal being circulated, the first scenario presented earlier this year, would have increased the taxable wage base to $12,000 by 2015. According to EDD, which is assuming an unemployment rate of 8.2 % by 2018, this scenario would bring solvency to the UI Fund by 2018.  The second scenario included a combination of a $12,000 taxable wage base and the increase in the minimum UI tax rate from 5.4 % to 8.1%.  According to EDD, which is assuming an unemployment rate of 8.7% by 2016, this would bring solvency to the UI Fund by 2016.

While it is unclear whether the proposal being circulated includes reforms other than tax increases, both scenarios presented earlier this year, were limited to tax increases alone because benefit cuts are believed to be a non-starter with labor unions.8 Additionally, labor unions are believed to have no incentive to compromise on a benefit reduction, because UI insolvency has no impact on benefits.

LAO Proposal

As mentioned above, UI Fund insolvency is not a new issue.  In fact, in July of 2011, the LAO issued a report making several recommendations to bring solvency to the UI Fund.  Like the Administration’s proposal, the LAO recommended that the taxable wage base be raised.  The LAO, however, suggested that it be increased to $15,000.  Unlike the Administration’s proposal, the LAO recommended benefit reductions, including a reduction in maximum weekly benefits from $450 to $375, tighter restrictions in eligibility requirements, and a reduction in the wage replacement rate from 50% to 45%.9

Employer Perspective

Employer representatives have yet to put out any specific proposal of their own. Yet, they have provided objectives that they believe must be the goal of UI system reform to ensure future solvency. Employer representatives believe that such reform should be comprehensive, realistic, and workable, and must not hinder job creation. Specifically, they believe that system reforms must address fraud, overpayment, and benefit eligibility. It is unlikely that any of the reform proposals in any of these areas will come close to offsetting the costs of the proposed tax increases. Some employer representatives have also floated the idea of bonding the UI debt.

Unfortunately, given the political landscape in Sacramento and the current makeup of the Legislature, employers would seem to have little leverage in negotiating a UI reform package that meets their desired objectives.

Inside and Outside Reforms

There are a number of reforms within the system that would make the system less costly and more efficient. As mentioned above, these reforms include changes to eligibility requirements, fraud prevention measures, and measures to address overpayment. Less palatable reforms could include those suggested above by the LAO, like a small reduction in benefits and the wage replacement rate. Again, none of these reforms, individually or collectively, would offset the costs of the various tax proposals. Nevertheless, any comprehensive system reform proposal should include them.

The single greatest reform would be to get the economy growing again and get more people back to work.  As such, it is entirely appropriate to consider economic reforms that are outside of the UI system as well.  These reforms could include economic stimulus proposals put forward in various bills this year by members of the Senate Republican Caucus, i.e. California Environmental Quality Act (CEQA), Assembly Bill (AB) 32, tort, and overtime reform.

Conclusion

Given the status of California’s insolvent Unemployment Insurance Trust Fund, its impact on employers, the economy and the state budget, as well as what appears to be Governor Brown’s desire to bring solvency to the system this year, the stars seems to be aligning in the final weeks of the 2013 legislative session for UI system reform that is intended to bring solvency to the system.  There are a number of ways that this can be done. Unfortunately, the proposals offered to date have, as their center piece, a tax increase.

This increase would come on the heels of increased workers’ compensation costs, permanent increases in employer fees to fund the Department of Industrial Relation’s enforcement activities, voter approved tax increases, and increased costs associated with Obamacare implementation.  In an economy that is just barely beginning to recover, each of these added costs individually are bad enough. Cumulatively they may be devastating.  As such, alternatives to a UI tax increase should be pursued.

Since the single greatest UI reform would be a growing economy, measures that would grow the economy should be considered as the alternative. CEQA, AB 32, tort, and overtime reform would be a great place to start.

For more information on this report or other Labor issues, contact Cory Botts, Senate Republican Office of Policy at 916/651-1501.




1 LA Times writer, Marc Lifsher, reported in April that Governor Brown’s Administration had convened various meetings with stakeholders, which included both business and labor representatives regarding UI Trust Fund insolvency. According to Lifsher, some of the participants described these meetings as “the most serious effort since the early 2000s to stabilize the system and keep benefits flowing.”

2 Raising UI taxes, e.g. the taxable wage base and/or the UI minimum tax rate, requires a 2/3rds vote of both houses of the Legislature.

3 Money to pay the interest on a UI fund loan from the federal government can’t be paid out of the UI fund.  It has to come from the General Fund or another source.   In 2012 and 2013, the Governor proposed to borrow money for the payment of this interest from the State Disability Insurance Fund.

4 The federal offset credit is a credit of 5.4% against the federal UI tax rate of 6.2%, which is paid by employers.

5 This is on a taxable wage base of $7,000 (e.g. an employee must make $7,000 or more in wages before UI taxes must be paid).

6 This is the 2020 unemployment rate predicted by EDD.

7 According to the Legislative Analyst Office, several factors contributed to the insolvency of the UI fund, including an increase of UI benefits in 2001 without a corresponding change in the funding mechanism and several years of worsening economic conditions which resulted in historically high levels of benefit payments, pushing the fund deeper into the red.

8 In the LA Times article mentioned above, Angie Wei, the chief lobbyist for the California Labor Federation is quoted as saying, “Labor won’t agree to a cut in California unemployment benefits.”

9 The wage replacement rate is the maximum percentage of wages that UI benefits will replace.