Managing California’s Insolvency: The Impact of Federal Proposals on Unemployment Insurance

Managing California’s Insolvency: The Impact of Federal Proposals On Unemployment Insurance M A C T A y l o r • l e g i s l A T i v e A n A l y s T • J u l y 2 0 11 An LAO RepOR t 2 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t ExECUTIvE SUMMary Background. The Unemployment Insurance (UI) program provides weekly benefits for workers who have lost their jobs through no fault of their own. The UI program is authorized in federal law, administered by California’s Employment Development Department (EDD), and is financed by contributions paid by employers. Many States Face UI Fund Insolvency. Beginning in 2008, the UI funds of many states, including California’s, were under stress and soon became insolvent. To continue payment of UI benefits, many states sought loans from the federal government. As of June 2011, California’s outstanding federal loan totaled over $10 billion. The state is required to make interest payments on its federal loan, the first of which is expected to total $320 million and is due September 2011. Federal Proposals Have Been Introduced to Correct UI Fund Insolvency. In response to UI fund insolvency in many states, three federal proposals have recently been introduced to address the insolvency issue. Two of these proposals introduce a comprehensive solvency plan aimed at ensuring the long-term solvency of states’ UI funds. In addition to providing a framework for achieving solvency, these two proposals would suspend state interest payments and federal UI tax increases on employers during the next two years. The third proposal includes significant changes to program financing in the short-term and tightens eligibility requirements which could substantially impact future costs of the UI program. Federal Proposals Could Solve California’s UI Fund Deficit. All three of the recent federal proposals would improve the solvency of California’s UI fund. We find that the two comprehensive solvency plans would likely eliminate California’s UI fund deficit by 2016 and put California on track to develop a sizeable reserve by the end of the decade. This improved solvency would come through a significant increase in the UI employer contributions—amounting to a total increase of $13 billion between 2012 and 2018 compared to current law. Pending Federal Proposals Complicate Difficult Choices for the Legislature. It is currently unclear whether any federal reforms will be enacted. This uncertainty complicates the Legislature’s decision as to how it should address the insolvency of its UI fund. By acting now, the Legislature could stop the growth of the UI fund deficit and reduce associated state interest costs. On the other hand, such actions have the disadvantage of increasing employment costs and/or decreasing aid to unemployed workers during what is likely to remain a difficult economic time for the state. Ensure Long-Term Solvency of the UI Fund. Regardless of whether Congress acts to address the UI insolvency problems faced by California and other states, we recommend that the Legislature ensure implementation of a long-term solvency plan by 2014. If federal reforms are enacted, it is likely that no additional action by the Legislature will be necessary to ensure long-term solvency. However, if no federal reforms are enacted, it will be critically important for the Legislature to adopt its own long-term solvency plan. In developing such a plan, we recommend that the Legislature consider an approach which includes both increased employer contributions and decreased benefits for UI claimants. www.lao.ca.gov Legislative Analyst’s Office 3 An LAO RepOR t InTrOdUCTIOn California’s UI fund has been insolvent since Many other U.S. states now face insolvency January 2009 and is expected to remain so for issues similar to California’s. In response, three the foreseeable future. To continue payment of proposals have been introduced in Congress UI benefits, the state has obtained loans from pertaining to UI fund insolvency problems in the federal government which now total over California and the other states. In this report we $10 billion. In our October 2010 report, California’s provide a brief update to the status of the UI fund, Other Budget Deficit: The Unemployment Insurance describe the federal proposals, consider their impact Fund Insolvency, we discussed the issue of the UI on California, and discuss how the Legislature may fund insolvency in detail and examined potential wish to address the insolvency of the UI fund. solutions. BaCkgrOUnd The UI program, which provides weekly work, be actively seeking work, and be willing to benefits to individuals who are unemployed accept a suitable job if offered one. through no fault of their own, was established Program Financing under the federal Social Security Act of 1935. Although the program is authorized by federal law, The UI program is financed by unemployment much discretion is given to states to set benefit and tax contributions paid by employers for each employer contribution levels. covered worker. Unemployment contributions have a federal and a state portion—both levied on Program Benefits a taxable wage base of $7,000 in California. The Under state law, UI weekly benefit amounts federal portion of unemployment contributions is are intended to replace up to 50 percent of a claim- primarily used to fund administration at the state ant’s earnings (defined as the wage replacement and federal level, while the state portion funds rate) during a 12-month base period—subject UI benefit payments. The federal unemployment to statutory minimum ($40) and maximum tax rate is 6.2 percent. However, a state’s effective ($450) limits. Regular UI benefits are paid for federal tax rate may be lowered to 0.8 percent as up to 26 weeks. However, during periods of high long as the state is in compliance with federal unemployment, additional extension programs are program requirements. (This is the case in typically available. In addition to being unemployed California.) Compliance with federal require- through no fault of their own, claimants must meet ments also allows the state to receive an annual additional monetary and nonmonetary eligibility federal grant to fund state administration of the requirements. To meet monetary eligibility require- UI program. State unemployment tax rates are set ments, a claimant must have earned (1) at least by a series of rate schedules ranging from AA (the $900 in a single quarter, as well as $1,125 total in a lowest rates) to F+ (the highest). A rate schedule is 12-month base period or (2) at least $1,300 in any selected annually based on the condition of the UI quarter in the base period. To meet nonmonetary fund. Contributions have been set to the highest eligibility requirements, a claimant must be able to rate schedule (F+) since 2004. 4 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t The UI Fund Is Insolvent the wage replacement rate to 50 percent (effective January 2003) and an increase in the maximum The UI fund became insolvent in January 2009 weekly benefit amount to $450 (effective January when benefit payments exceeded the available 2005). This nearly doubled the maximum weekly balance of the UI fund. By the end of 2009, the UI benefit amount. The legislation did not provide for fund deficit totaled $6.2 billion. In 2010, benefit any changes to the UI financing mechanism to pay payments again exceeded UI fund revenues by for these additional benefit costs. $3.6 billion. As a result, the UI fund ended 2010 UI Financing Structure Unable to Adjust for with a deficit of $9.8 billion. Current forecasts Increased Costs. As mentioned previously, the state suggest that the deficit may continue to grow for unemployment tax rate is determined by a series of several years without action to bring the fund schedules ranging from AA (the lowest) to F+ (the into balance. As shown is Figure 1, the deficit is highest). The effective schedule is adjusted annually estimated to reach $12.7 billion by the end of 2012. based on the UI fund condition. The series of tax While still substantial, this projected deficit is rate schedules is intended to allow flexibility in the significantly less than previous EDD estimates. This UI financing structure to account for the cyclical reduction is due to a slightly improved outlook for nature of UI benefit payments. Fundamentally, California’s economy and the receipt of additional the system of tax rate schedules is intended to federal funds. allow the revenues flowing into the UI fund to Several factors contributed to the insolvency of increase in response to significant increases in UI the UI fund, including an increase of UI benefits benefit payments and decline during improved in 2001 without a corresponding change in the economic conditions. However, despite significant funding mechanism. Several years of worsening economic conditions resulted in historically Figure 1 high levels of benefit Unemployment Insurance Fund Out of Balance payments, pushing the (In Billions) fund deeper into the red. $15 Past Changes to UI Benefit Provisions. Between 1992 and 10 2001, UI weekly benefit payments covered up to 5 39 percent of a claimant’s previous weekly base 0 period earnings—subject to a statutory maximum -5 Benefits of $230. Chapter 409, Contributions Statutes of 2001 (SB 40, Fund Balance -10 Alarcón), established the benefit levels currently -15 in effect by instituting 2005 2006 2007 2008 2009 2010 2011 2012 a phased increase of Estimated www.lao.ca.gov Legislative Analyst’s Office 5 An LAO RepOR t fluctuations in the state’s unemployment rate since Figure 2 shows projected federal loan balances and 2004 (unemployment rates were less than 5 percent the state’s interest costs absent corrective action. in 2006 and greater than 13 percent in 2010), UI The amounts shown in Figure 2 were calculated by tax rates have remained steady at schedule F+ (the the EDD based on LAO’s economic assumptions. highest schedule). Under the current statutory These figures are very similar in the short run to constraints on UI tax rates, the UI program’s those contained in the EDD’s May 2011 forecast of financing structure can no longer adjust sufficiently the UI fund condition. However, in the long run, as to pay the increasing costs of the UI program. the LAO’s economic forecast assumes slightly lower unemployment than the EDD, the figures differ The Costs of Insolvency from EDD’s forecast. Since the UI fund became insolvent in January 2009, the state has received quarterly loans from Figure 2 the federal government in order to continue Federal Interest Payments Will Be a payment of UI benefits without interruption. As Significant Cost to the General Funda of June 2011, the state’s outstanding federal loan (In Millions) balance was about $10 billion. Absent corrective Loan Interest Year Balance Payment action, the state is expected to continue borrowing for the remainder of the decade, if not longer. 2011 $10,108 $319 2012 11,714 448 Continual borrowing has negative ramifications 2013 12,263 417 for the state, particularly in the cost to the state 2014 11,598 370 of ongoing interest payments and increases in 2015 10,015 371 2016 7,719 348 the effective federal unemployment tax rate on 2017 5,287 283 California employers. 2018 2,745 185 a Interest Payments. Under federal law, the Estimates calculated using Employment Development Department models and LAO’s economic forecast. state must pay interest on any federal loans to the UI fund that are not repaid within the same calendar year. Due to historically high levels of Increased Federal Tax Rate. If a state carries a unemployment, and the financial pressure this federal loan balance for two consecutive years, the situation placed on a number of states, Congress state’s effective federal unemployment tax rate must has suspended these interest payments in recent begin to increase incrementally. In recent years, years. However, as of January 1, 2011, the state federal legislation has suspended this provision. began accruing interest on its federal loan at an However, absent further action by Congress in the annual rate of roughly 4 percent. The state’s first coming months, the federal unemployment tax rate interest payment, which is expected to be about charged to California employers will increase as of $320 million, is due in September 2011. As federal January 1, 2012 by 0.3 percent because the state will law requires that these interest payments be made continue to carry an outstanding loan balance. This from state funds, the cost of the payments will incremental increase in the employer tax rate is likely fall on the state’s General Fund. Without expected to result in the collection of $300 million changes to the UI program, interest payments on in additional contributions from employers in the federal loan are expected to be a significant 2012. If the state continues to carry an outstanding cost to the General Fund for the foreseeable future. loan balance, the federal tax rate will increase by 6 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t an additional 0.3 percent Figure 3 each year through 2014, Federal Administration Surcharges at which time the incre- If Federal UI Loan Is Not Repaid mental increases would Annual Surcharge Increase in Employer Cost be larger. (Hereafter, Year Per Employee (In Millions) we refer to these incre- 2012 $25 $304 mented tax increases as 2013 50 629 federal administration 2014 78 985 2015 106 1,356 surcharges.) 2016 135 1,745 Figure 3 details 2017 165 2,154 the annual increase in 2018 195 2,565 employer costs that are projected to result from from the surcharges are applied to the state’s the federal administration surcharges. Revenues outstanding federal loan balance. FEdEral PrOPOSalS TO addrESS UI FUnd InSOlvEnCy Three proposals have recently been introduced the short and long term. The President’s proposal in Congress that would have a significant and contains four key provisions: (1) suspending state sustained impact on UI programs in most states, interest payments on federal UI fund loans for including California. Two of the proposals offer two years, (2) suspending federal administration comprehensive plans to resolve the UI fund insol- surcharges for two years, (3) increasing the federal vencies experienced by many states. In the short run minimum taxable wage base to $15,000 in 2014 and (over the next three years) these two proposals would indexing the wage base to the change in the average provide interest payment relief to the state’s General annual wage in subsequent years, and (4) reducing Fund and eliminate potential federal administration the federal unemployment tax rate effective 2014. surcharges on California employers. In the long Suspension of Interest Payments. As discussed, run, changes in the UI financing structure would absent a change to federal law, the state will be be expected to put the UI fund on a path toward required to make an interest payment of roughly solvency and allow for repayment of the federal UI $320 million in September 2011. In 2012, this interest loan within five years. A third, less comprehensive, payment is expected to grow to about $448 million. proposal would reduce federal support for extended These costs are likely to be borne by the state of UI benefits, transfer the federal savings to state UI California’s General Fund. By suspending interest funds, and make other changes affecting the eligi- payments over the next two years, the President’s bility of current program recipients. We outline all proposal would eliminate this cost to the General three of these proposals below. Fund, resulting in expected savings of over $750 million during the next two years. President’s Proposal Suspension of Federal Administration The President’s 2012 federal budget includes Surcharges. As a result of carrying a federal loan a proposal to address UI fund insolvency in both balance, under current federal law the effective www.lao.ca.gov Legislative Analyst’s Office 7 An LAO RepOR t unemployment tax rate on California employers the future. These additional provisions are: (1) a would increase by 0.3 percent on January 1, 2012 mechanism for partial forgiveness of federal loans and an additional 0.3 percent on January 1, 2013. to state UI funds and (2) reduced federal tax rates The President’s proposal eliminates this increase and increased interest earnings for states that meet in the federal tax rate for 2012 and 2013—avoiding certain solvency targets. Below is a brief description increases in employer contributions in those years of these additional provisions. by $300 million and $630 million, respectively, that Federal Loan Abatement. The legislation would otherwise be required. includes a so-called abatement provision which Increase in the Taxable Wage Base. California would forgive as much as 60 percent of a state’s currently collects employer contributions on the first outstanding federal loan if it agreed to meet $7,000 in annual wages paid per covered employee. specific UI fund solvency targets. To do so, the state This wage base is the minimum amount allowable would work with the U.S. Department of Labor under current federal law. The President’s proposal to construct a solvency plan which would allow would more than double the minimum taxable wage the state to: (1) repay any remaining outstanding base to $15,000 in 2014 for all states. In addition, federal loan balance and (2) improve the state’s UI the taxable wage base would then be indexed to the fund solvency to a level such that reserves would change in the average annual wage in subsequent be adequate to pay one year of UI benefits even if years. This proposed increase in the taxable wage they were at historically high levels. (Technically, base is somewhat less than the increase in the this level of solvency is defined as an average high average annual wage since 1983, the year in which cost multiple [AHCM] of 1.0. See the nearby box the federal taxable wage base was last adjusted. for additional discussion of AHCM.) During the Reduction in the Federal Unemployment effective period of the abatement agreement (no Tax Rate. As discussed previously, the UI tax rate longer than seven years), the state would not be charged to California employers has both a state allowed to lower UI benefit levels or adopt more and federal portion which are both charged on stringent UI eligibility requirements. the federal minimum taxable wage base. Absent Rewards for Solvent States. The federal a change in the state portion of the UI tax rates, government currently pays states interest whenever the President’s proposed increase in the taxable there are positive balances in their UI funds. wage base would significantly increase the state For example, the federal government deposited portion of UI employer contributions. However, $98 million in earned interest into the state’s UI the President’s proposal avoids a net increase in the fund in 2008 (a period before California’s UI fund federal portion of UI employer contributions by became insolvent). To encourage states to improve roughly halving the federal unemployment tax rate. UI fund solvency to an AHCM of 1.0, the act increases the interest paid on UI fund balances by Unemployment Insurance Solvency act 0.5 percent for those states that meet this solvency The proposed Unemployment Insurance target. In addition, states meeting the act’s require- Solvency Act of 2011, introduced to the U.S. Senate ments would be provided a reduction in their on February 17, 2011, sets forth a solvency plan effective federal unemployment tax rate. Potentially, that is identical to the President’s except for two these rate reductions would decrease federal additional provisions. Both of these provisions unemployment taxes for California employers by are intended to provide greater incentives for hundreds of millions of dollars annually. states to ensure the solvency of their UI funds in 8 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t A H C M (AHCM) verAge igH ost ultiple The AHCM is a widely used metric of Unemployment Insurance (UI) fund solvency which measures the number of years a UI fund could pay benefits at recessionary levels without additional UI employer contributions. The U.S. Department of Labor has concluded that an AHCM equal to 1.0—whereby a state would be able to pay one year of historically high benefits without additional revenue—represents a minimum acceptable level of solvency. Evidence from the most recent recession (December 2007 to June 2009) provides some support for this conclusion. Immediately prior to the recession, six states had an AHCM of 1.0 or greater. Of these, only one had to obtain a loan from the federal government as a result of the recession. Overall, 32 states had to obtain federal loans. The average AHCM of states that received a federal loan was 0.39, as compared to 0.83 for states that did not receive a federal loan. Calculation of AHCM. The AHCM is calculated in three steps: • Calculate what is known as a reserve ratio. A reserve ratio is calculated by dividing the balance of the state’s UI fund by the total wages paid to covered employees in the preceding twelve months. • Calculate what is known as an average high cost rate. This calculation proceeds in two steps: (1) for each of the preceding 20 calendar years, the amount of benefits paid is divided by the total wages paid to covered employees and (2) the highest three values are averaged. • Divide the reserve ratio by the average high cost rate. By comparing the reserve ratio and the California’s UI Fund Condition Has Worsened average high cost rate, Significantly Over Time the AHCM reports As Measured by the Average High-Cost Multiple the duration for which 1.5 current fund balances could cover benefit costs Federal Solvency Target 1.0 if they were at histori- cally high levels. 0.5 AHCM of 1.0 a Historically High 0.0 Target for California. As shown on the nearby -0.5 graph, California’s UI fund solvency has been -1.0 trending downward 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 significantly over the past 20 years. The state has not achieved an AHCM of at least 1.0 since 1990. Since full implementation of the state’s most recent statutory increase in UI benefits (passed in 2001), the state’s AHCM has not exceeded 0.32. www.lao.ca.gov Legislative Analyst’s Office 9 An LAO RepOR t JOBS act the anticipated federal costs for extended benefits for California claimants in these years. Although the proposed Jobs, Opportunity, Additional Eligibility Requirements. As Benefits and Services (JOBS) Act, introduced in discussed previously, California’s UI program both houses of the U.S. Congress on May 5, 2011, is must meet specific federal requirements in order to not intended to be a plan to return states UI funds qualify for a reduced effective federal UI tax rate to solvency it would make two significant changes and annual federal grants to administer the UI to the UI program. program. Another major change proposed by the Proposed Block Grant. When the federal JOBS Act is to add two provisions to these federal government extends unemployment benefits requirements related to non-monetary eligibility beyond the state-authorized 26 weeks, it generally requirements for receipt of UI benefits. The pays for most, if not all, of the benefit costs. current federal requirement that UI claimants be Currently, unemployed Californians may receive “actively seeking work” to receive benefits would be up to 99 weeks of benefits, with the final 73 weeks amended to specifically require that all claimants funded by the federal government. The proposed register for state administered employment services JOBS act replaces the funding now used for (programs which provide job search assistance to extended benefits with federal block grants and unemployed workers) and post a resume in a state- relieves states of the obligation to provide extended maintained database. Moreover, as a condition benefits. The block grants could be used for of receiving UI benefits, all claimants would be (1) continued payment of extended benefits if required to have earned a high school diploma or a state elected to provide them, (2) payment of General Educational Development credential or regular UI benefits, (3) repayment of federal UI be making satisfactory progress in classes toward loans, and (4) reemployment services. Preliminary such credentials. Although insufficient data calculations based on the most recent available exists to quantify the impact of these eligibility data suggest California would receive block grants requirements, it is likely that they would result in of around $1.8 billion and $2.6 billion, in 2011 and a significant overall reduction in the number of 2012 respectively. According to EDD projections, California workers eligible to receive benefits. these block grant amounts would slightly exceed EvalUaTIng ThE FEdEral PrOPOSalS The federal proposals would likely have President’s proposal and the Unemployment significant impacts on California’s UI program, Insurance Solvency Act, it is likely that the act as well as California’s economy. To explore these would result in a similar or slightly improved level impacts, we have examined and compared forecasts of UI fund solvency as compared to the President’s of the UI fund condition under current law and the proposal. Moreover, we were unable to model the President’s proposal. impacts in California of the JOBS Act because its Because of technical complications, we were ultimate impact on the solvency of California’s UI unable to model the loan abatement provisions fund would be dependent upon the state’s use of of the Unemployment Insurance Solvency Act. block grants and the degree to which the new eligi- However, due to the similarity between the bility requirements described above would reduce 10 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t the number of workers eligible to receive benefits. contrast, our forecast indicates that the President’s Our review indicates that the measure would likely proposal would eliminate the UI fund deficit by improve the condition of California’s UI fund but 2016. In addition, under the President’s plan, the not restore it to solvency. UI fund would accumulate a reserve of about Our forecasts of the UI fund condition under $10 billion by the end of 2018. In Figure 4 we the President’s proposal go out seven years and display how the balance of the UI fund would are based on the LAO’s current economic outlook. change under both the President’s proposal and In general, the LAO’s economic outlook assumes current law over the period 2012 to 2018. a gradual and sustained recovery. It is important Under the President’s proposal, the UI fund to note that these forecasts are very sensitive to deficit is projected to peak in 2014, while under changes in future economic conditions as both current law it is projected to peak in 2013. As the employer contributions and benefits paid fluctuate President’s proposal suspends federal admin- with changes in the unemployment rate. Below, we istration surcharges until 2014, the maximum compare the President’s proposal to current law in deficit is actually higher under the President’s the areas of UI fund solvency, state interest costs, proposal ($14.6 billion) than under current law and impacts on employment costs. ($13.2 billion). However, beginning in 2014 the pace of improvement in the UI fund is much greater UI Fund Balance under the President’s proposal than current law. If no action is taken to address the UI fund Between 2014 and 2018, the UI fund deficit is deficit, the fund is likely to maintain a negative expected to decrease by an average of $2.2 billion balance through the remainder of the decade. In per year under current law, as compared to an average of $5.2 billion per year under the President’s Figure 4 proposal. As a result, President’s Proposal Eliminates California’s Unemployment Insurance Fund Deficit the President’s proposal is projected to have a (In Billions) positive UI fund balance $15 of about $10.1 billion by the end of 2018, whereas 10 President's Proposal under current law there Current Law would be a deficit of 5 $3.5 million at the end of 0 this period. -5 State Interest Costs As previously -10 discussed, without -15 corrective action the state will face significant -20 ongoing interest costs 2012 2013 2014 2015 2016 2017 2018 due to continued federal www.lao.ca.gov Legislative Analyst’s Office 11 An LAO RepOR t borrowing. Under current law, these interest period would amount to around $800 million. payments would be hundreds of millions of dollars Altogether, state interest costs during the period annually and total almost $3 billion through 2018. 2011 to 2018 would be about $1.7 billion less under However, as shown in Figure 5, these interest the President’s proposal than under current law. costs would be significantly reduced under the Increased Employer Contributions President’s proposal. Suspension of interest payments in 2011 and 2012 would reduce state Figure 6 details total annual employer interest costs by a total of $767 million. In addition, contributions to the UI fund under the President’s as it is anticipated that the federal loan would be proposal and under current law. The President’s repaid by 2016 under the President’s proposal, the proposal would result in a considerable increase state would not incur any interest costs in 2016 in total employer contributions to the UI fund— or succeeding years. Interest savings during this about $13 billion over the forecast period. In the next two years, however, the President’s proposal Figure 5 would result in a small reduction in total employer Comparison of UI Interest Payments Under contributions due to the elimination of the federal Current Law and President’s Proposal administration surcharge. (In Millions) Figure 7 compares annual employer contribu- President’s tions per employee and effective tax rates (total Year Current Law Proposal employer contributions as a percent of total wages) 2011 $319 — under the President’s proposal and under current 2012 448 — law. In 2012 and 2013, both the contributions per 2013 417 $443 2014 370 383 employee and effective tax rates on employers 2015 371 259 would be slightly lower under the President’s 2016 348 — proposal than under current law. However, for 2017 283 — 2014 through 2016 contributions per employee 2018 185 — Totals $2,741 $1,086 and effective tax rates would increase roughly 40 percent over those required under current law. Figure 6 Comparison of UI Employer Contributions Under Current Law and President’s Proposal (In Billions) Current Law President’s Proposal Federal Federal Base Administration Total Base Administration Total Year Contributions Surcharge Contributions Contributions Surcharge Contributions 2012 $5.4 $0.3 $5.7 $5.4 — $5.4 2013 5.4 0.6 6.0 5.4 — 5.4 2014 5.6 1.0 6.6 9.0 $0.3 9.3 2015 5.7 1.4 7.1 9.8 1.2 11.0 2016 5.8 1.7 7.5 9.5 1.9 11.4 2017 5.8 2.2 8.0 9.7 — 9.7 2018 5.8 2.6 8.4 10.2 — 10.2 Totals $39.5 $9.8 $49.3 $59.0 $3.4 $62.4 12 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t During the period from 2014 to 2018, annual proposal. By 2018, the UI fund could be expected employer contributions to the UI fund under the to have a balance of about $10 billion. This balance President’s proposal are expected to exceed benefits would represent an AHCM of 0.71, which would paid to recipients, which would allow the state to be the highest level of UI fund solvency since 2001. repay its federal loan and build a reserve. After The improved solvency of the UI fund would be 2018, as the state builds a sufficient reserve, it would expected to save the state $1.7 billion in General likely result in a decrease in the employer contri- Fund costs during the 2012 to 2018 period. bution rate schedule, which would reduce employer Drawbacks of the President’s Proposal. contributions in the out-years. The President’s proposal relies exclusively on increased employer contributions to address UI Benefits and drawbacks of the fund insolvency. A potential drawback of such a President’s Proposal strategy is that it fails to spread negative impacts While the President’s proposal would make across all parties. Rather, the proposal’s direct significant progress in improving the health impacts are focused on employers in the form of California’s UI fund, it does have potential of increased employment costs. While these drawbacks. Below, we briefly summarize the increased employment costs are imposed directly potential benefits and drawbacks of the President’s on employers, a significant portion of these impacts proposal. would ultimately be passed along to workers in the Benefits of the President’s Proposal. The most form of reduced hiring and decreased wages. All immediate benefit of the President’s proposal is other things being equal, we believe that higher that it avoids negative impacts on the state, UI employer contributions will reduce, to some extent, claimants, or employers over the next two years, the employment gains that are likely to occur as the a period during which unemployment is expected economy recovers. to remain high. The President’s proposal achieves this by suspending both Figure 7 state interest payments in Comparison of UI Employer Costs Under Current Law 2011 and 2012 and federal And President’s Proposal administration surcharges Current Law President’s Proposal on employers in 2012 and Contributions Effective Contributions Effective 2013, while maintaining Year Per Employee Tax Rate Per Employee Tax Rate current UI benefit levels 2012 $467 0.91% $442 0.86% for claimants. 2013 480 0.91 430 0.81 2014 517 0.95 739 1.46 Also, the solvency 2015 549 0.96 853 1.49 of California’s UI fund 2016 579 0.97 881 1.47 would increase dramati- 2017 606 0.97 742 1.19 2018 637 0.97 775 1.18 cally under the President’s www.lao.ca.gov Legislative Analyst’s Office 13 An LAO RepOR t WhaT ShOUld ThE lEgISlaTUrE dO nOW WITh POTEnTIal FEdEral aCTIOn PEndIng? The insolvency of California’s UI fund poses Potential Interim Actions. If the Legislature significant problems for California. Absent reform wishes to act now to stop growth in the UI fund of the UI program, payments from the UI fund deficit, it would need to bring UI fund revenues and are expected to continue to exceed revenues, benefit payments into balance. If no federal actions resulting in continued borrowing from the federal are taken, the annual gap between revenues and government and associated state interest costs. benefit payments is anticipated to be $1.6 billion As described in the previous section, two federal and $0.5 billion in 2012 and 2013, respectively. proposals have been introduced which would The Legislature has three primary options for likely eliminate California’s UI fund deficit and eliminating this gap: (1) increasing employer establish a significant reserve by the end of the contributions, (2) decreasing benefits paid to UI decade without the need for additional state action. claimants, or (3) a combination of the first two However, it is currently unclear whether these, options. For example, increasing the taxable wage or any other congressional solvency legislation, base to $11,000 in 2012 and 2013 would bring will be enacted. This uncertainty complicates the annual revenues and spending in line, thereby Legislature’s decision as to how it should address stopping growth in the UI fund deficit during the insolvency of the UI fund. Below, we provide this period. Decreasing the maximum weekly guidance for the Legislature in managing the insol- benefit amount from $450 to $400 along with vency issue in light of potential federal actions. a reduction in the wage replacement rate from 50 percent to 45 percent would achieve the same Consider Early action end. Alternatively, the Legislature could moderate In October 2010, prior to the introduction the above changes by combining increased of the federal proposals described previously, we employer contributions with decreased benefits. recommended that the Legislature take prompt In selecting among these options, the Legislature action to stop the growth of the UI fund deficit. should carefully weigh the effects of each option on In our report, California’s Other Budget Deficit: various parties within the UI system—employers, The Unemployment Insurance Fund Insolvency, employees, and unemployed workers. we argued that by doing so the Legislature could Advantages and Disadvantages of Early mitigate state interest costs and minimize the Action. By acting now to stop growth in the UI overall problem that ultimately must be addressed fund deficit, the Legislature could reduce ongoing with future comprehensive reform. While the annual state interest costs by about $50 million. potential benefits of immediate state legislative Also, the magnitude of the problem that must be action remain significant, we note that two solved by future reforms would be reduced by about recent developments now also need to be taken $2 billion. However, taking immediate action has into account. These are the potential actions by the disadvantage of increasing employment costs Congress to address the states’ UI insolvencies and/or decreasing aid to unemployed workers as well as an improvement in the outlook of during what is likely to remain a difficult economic California’s UI fund since the publication of our time for the state. In addition, pending federal October 2010 report. 14 Legislative Analyst’s Office www.lao.ca.gov An LAO RepOR t proposals could make any state actions unnecessary. from $7,000 to $15,000 and indexed to the average For this reason, the Legislature may instead wish to annual wage in subsequent years. Our approach take a wait-and-see approach during 2011 and 2012 would go further than the President’s by taking until it is clear what actions Congress has taken. three actions to reduce UI benefit levels. These actions are: (1) reducing the maximum weekly adopt a long-Term Solvency Plan benefit amount from $450 to $375, (2) increasing Although a wait-and-see approach may the 12-month monetary eligibility requirement be appropriate during the next two years, we from $1,125 to $4,000, and (3) reducing the wage recommend that the Legislature ensure that imple- replacement rate from 50 percent to 45 percent. mentation of a long-term solvency plan begins Similar to the taxable wage base, the maximum no later than 2014. If federal reforms—such as weekly benefit amount would be indexed to the the President’s proposal—are ultimately enacted, average annual wage in subsequent years. We note it is likely that the no additional action will be that, due to indexing, the maximum weekly benefit required of the Legislature to ensure long-term amount would be expected to return to around solvency of the UI fund. However, depending on $450 within five years. the future condition of California’s labor market, The Major Impacts of the Plan. As mentioned the Legislature should evaluate the composition of above, if our approach were implemented in 2014, federal reforms to determine if further state action it would likely result in the elimination of the UI is warranted. fund deficit by 2016 and the establishment of a If federal reforms are not enacted in the next significant UI fund reserve by 2018. This would be two years, we recommend that the Legislature accomplished by increasing employer contributions adopt its own comprehensive solvency plan. While by a total of about $11 billion and decreasing benefit the Legislature has several options for doing so, we payments by a total of about $4 billion during the recommend that it consider a plan that combines period 2014 to 2018, as compared to current law. increased employer contributions and decreased Consequently, the average employer contribution benefits for UI claimants. We believe such an per employee would increase by roughly 60 percent approach offers a reasonable trade-off between during this period, while the average weekly benefit the impacts of increased employment costs and paid to UI claimants would decrease by about reduced assistance for unemployed workers. Below, 12 percent. Under this approach, state interest costs we outline one such solvency plan. would be reduced by $1.3 billion. Overall, this Description of the Plan. Under our proposed approach is intended to return California’s UI fund approach, employer contributions would be to solvency in a timely manner while balancing increased in an identical manner to the President’s the impacts of increased employment costs and proposal. The taxable wage base would be increased reduced assistance for unemployed workers. www.lao.ca.gov Legislative Analyst’s Office 15 An LAO RepOR t LAO Publications This report was prepared by Brian uhler, and reviewed by Todd Bland. The legislative Analyst’s office (lAo) is a nonpartisan office which provides fiscal and policy information and advice to the legislature. To request publications call (916) 445-4656. This report and others, as well as an email subscription service, are available on the lAo’s website at www.lao.ca.gov. The lAo is located at 925 l street, suite 1000, sacramento, CA 95814. 16 Legislative Analyst’s Office www.lao.ca.gov