The 2021-22 Budget: Interest Payment on Federal Unemployment Insurance Loan

analysis full gutter The 2021-22 Budget: Interest Payment on Federal Unemployment Insurance Loan FEBRUARY 2021 Introduction The California labor market collapsed in late level of unemployment, the state’s UI Trust Fund, March and early April due to the coronavirus which collects payroll taxes that fund UI benefits, disease 2019 (COVID-19) pandemic. By April, became insolvent during the summer of 2020. To 2.6 million California workers were unemployed and continue paying weekly UI benefits after the fund therefore eligible for state unemployment insurance became insolvent, the state took on available (UI) benefits. For comparison, during the Great federal loans. Under federal law, the state must Recession, the number of unemployed workers make annual interest payments on outstanding peaked at 1.3 million. Due to this unprecedented loans until the loans are repaid. Background UI Program Assists Unemployed Workers. The for state UI program administration costs and is set UI program provides weekly benefits to workers at a rate of 0.6 percent. Both state and federal UI who have lost their jobs through no fault of their payroll taxes are applied to each employee’s first own. The federal government oversees state UI $7,000 in annual wages. programs but the state has significant discretion to States May Borrow From Federal Government set benefit and employer contribution levels. Under During Economic Downturns. During recessions, current state law, weekly UI benefit amounts are the state’s UI trust fund can become insolvent intended to replace up to 50 percent of a worker’s as the cost of benefits exceed employer tax prior earnings, up to a maximum of $450 per week, contributions and trust fund reserves are for up to 26 weeks. In 2019, the average benefit exhausted. Federal law allows states, when they amount was $330 per week. exhaust their state UI trust funds, to receive loans UI Program Is Financed With Payroll Taxes from the federal government to continue paying Paid by Employers. Employers pay both state benefits. These loans must be repaid, with interest and federal UI payroll taxes. State UI tax revenues (currently 2.3 percent annually), at a later time. The are deposited into the state’s UI trust fund to pay loan principal is repaid by automatic increases in benefits to unemployed workers. State UI tax rates the federal UI tax rate that are set out in federal are set based on rate schedules laid out in state law. The loan interest typically has been paid from law. The schedules require higher rates, up to a states’ General Funds. maximum of 6.2 percent, when the condition of California Has Received Substantial Federal the UI trust fund is poor—meaning that it has a Loans. California, like many other states, has used low level of reserves. Due to longstanding solvency these federal loans to continue paying benefits issues, the state’s UI tax rate has been at this during the pandemic. As of February 2021, the maximum amount since 2004. When the trust fund state has received $18.5 billion in federal UI loans reserve is larger, schedules with lower tax rates are to cover state UI benefit costs. (This state debt in place. The federal UI tax is typically used to pay is only related to paying regular state UI benefits. 2021-22 LAO Budget Series 1 analysis full gutter The state does not need to borrow to pay for certain circumstances. Specifically, if the average the temporary benefit increases and extensions state unemployment rate exceeded 7.5 percent that the federal government enacted during the during the first six months of the prior calendar pandemic because these benefits are 100 percent year (in this case, January through June 2020), the federally funded.) California also received federal state may pay 25 percent of the interest due. The loans during the Great Recession. The state’s peak remainder (75 percent) would be repaid in three year-end balance of loans was $10.2 billion at the 25 percent portions over the next three years. end of 2012. Between 2011 and 2018, the state Interest payments deferred under this provision do General Fund paid a total of $1.4 billion in interest not accrue additional interest. To our knowledge, payments on these loans. no state has ever used this provision to defer Rarely Used Provision of Federal Law Allows accrued interest payments, largely because the States to Defer UI Interest Payments. Under provision is not widely known. At our request, federal law (42 United States Code Section 1322), however, the administration received confirmation states are eligible to delay upcoming interest from the U.S. Department of Labor that California payments on federal UI trust fund loans under currently is eligible for this interest deferral. Proposal $555 Million Estimated General Fund Interest corresponds to the full interest payment, not the Payment. The 2021-22 Governor’s Budget 25 percent that would be due under the interest proposes $555 million General Fund to make the payment deferral discussed above.) The estimated first annual interest payment on federal UI trust fund interest payment is due September 30, 2021. loans received during the pandemic. (This amount Analysis $555 Million Interest Payment Estimate $48 billion. Taking updated economic conditions Based on Outdated Economic Forecast… The into account, we believe the 2021 year-end federal administration’s interest payment estimate is based loan balance is likely to be closer to $25 billion. on underlying economic assumptions made by the …Does Not Reflect Extended Interest Department of Finance in April, 2020. At that time, Waiver Under Recent Federal Law. The both the administration and our office estimated federal Families First Coronavirus Response that the economic consequences of the pandemic Act, enacted in March 2020 in response to the would be severe and prolonged. Since then, the COVID-19 pandemic, allows states to waive actual consequences have become clear and, interest accrued during calendar year 2020 on though substantial, were not nearly as severe as federal UI loans. The administration’s interest we had anticipated. However, the administration’s payment estimate accounts for this waiver. interest payment estimate is based on these However, after the administration developed its outdated forecasts. Specifically, the estimate is estimate, the federal government, on December based on the assumption that the average state 27, extended the interest accrual waiver from unemployment rate in 2021 will be 18 percent. the end of 2020 through March 14, 2021. As a The state’s current unemployment rate is about result, the state’s interest payment for 2021-22 half that level. As a result, the $555 million interest will cover roughly 6 months of accrued interest payment is based on an implausibly large projection (March 15 through September 30), whereas the of outstanding federal loans at the end of 2021— administration’s interest payment estimate reflects 2021-22 LAO Budget Series 2 analysis full gutter 9 months of interest. The administration has stated federal UI loans will total roughly $260 million. that it plans to update their interest payment This amount is roughly $300 million less than the estimate as part of the May Revision to account for amount estimated by the administration. This the recent federal law change. lower estimate reflects a lower projection of federal As a Result, Governor’s Budget Overstates loans outstanding (based on current economic Interest Payment by Roughly $300 Million. conditions) and a shorter interest accrual duration We estimate the state’s first interest payment on period (based on the recently extended waiver). Recommendation Adopt Updated $260 Million Estimate of Defer Interest Until Later Years. In addition Federal Interest Payment Due. We recommend to adopting an up-to-date estimate of the total the Legislature adopt an up-to-date estimate of interest payment, we recommend the Legislature the overall interest amount likely due in September. adopt provisional budget legislation to request an For planning purposes, we suggest the Legislature interest payment deferral from the U.S. Department adopt our estimate of $260 million. This estimate of Labor, given that the deferral does not have the reflects current economic conditions and federal effect of increasing state payments. This would law. If the federal government takes further action allow the state to pay one-quarter of this year’s to extend the interest waiver beyond March 14, interest payment in 2021-22 and an additional this estimate would need to be revisited and one-quarter in each of the next three years. Should likely reduced accordingly. Mindful of this shifting the Legislature pursue this course, we estimate that landscape, the administration and our office will the total interest due this year would be roughly provide an updated estimate as part of the May $65 million. Revision. LAO Publications This report was prepared by Chas Alamo, and reviewed by Brian Uhler and Carolyn Chu. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. 2021-22 LAO Budget Series 3