LAO
Fixing Unemployment Insurance
Read the report at Legislative Analyst's Office ↗
2025-26 BUDGET
Fixing
Unemployment Insurance
GABRIEL PETEK | LEGISLATIVE ANALYST
DECEMBER 2024
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2 LEGISLATIVE ANALYST’S OFFICE
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Executive Summary
The State’s Unemployment Insurance (UI) Financing System Is Broken. The state’s
UI program is supposed to be self-sufficient—that is, the system should collect enough funds to
pay for benefits over time. This means, in some years, the system will collect more than necessary
so that, during most economic downturns, there is enough money to pay for rising benefit costs.
That system is broken: tax collections routinely fall short of covering benefit costs. (The state’s fiscal
problems are unrelated to the widespread fraud that affected temporary federal UI programs during
the pandemic.) Both our office and the administration expect these annual shortfalls to continue
for the foreseeable future. Under our projections, deficits would average around $2 billion per year
for the next five years. This outlook is unprecedented: although the state has, in the past, failed to
build robust reserves during periods of economic growth, it has never before run persistent deficits
during one of these periods.
Mounting Consequences of the State’s Broken UI Financing System. The state’s broken
UI system now presents mounting consequences:
• Annual Shortfalls Will Balloon Outstanding Federal UI Loan. Anticipated annual shortfalls
will add to the state’s looming $20 billion outstanding federal UI loan. We expect the loan to
grow by billions of dollars before federal surcharge UI taxes are high enough for the state and
employers to begin making progress toward repaying the loan.
• Loans Will Become a Permanent Feature of UI and a Major Ongoing Taxpayer Cost.
The state will need to borrow from the federal government in most years to make up the gap
between UI benefits and contributions. This means that businesses could face a perpetually
outstanding federal loan, on which the state must make interest payments. These interest
costs will be significant, likely around $1 billion per year, and paid by the state’s taxpayers.
• UI Program Will Be Unable to Build Reserves Ahead of Next Recession. Although a
federal surcharge on businesses will help repay the federal loan, the surcharge cannot help
the state build reserves after the loan is repaid. This is because the surcharge turns off once
the loan balance reaches zero. Absent the federal surcharge, little or no reserves would be
on hand at the start of the next recession, further increasing the state’s reliance on costly
federal loans.
Broken Financing System Also Undermines Key Objectives of the UI Program. The state’s
UI system faces other problems, too. First, state UI benefits cannot keep up with inflation or provide
the intended wage replacement of half of workers’ wages. Second, the state’s approach to setting
employer tax rates (a system called “experience rating”) has the effect of depressing take-up of
UI benefits among eligible, unemployed workers. Third, the state’s lowest-in-the-nation taxable
wage base deters employers from hiring lower-wage workers. In each case, our proposed fixes to
the UI financing system would eliminate, or at least mitigate, these related shortcomings.
Four Recommendations to Fix the System. The state’s UI tax system requires a full redesign
so that contributions: (1) cover benefit costs in most years and (2) build up a reserve that can be
drawn down during recessions. We recommend four main areas of change:
• Substantially Increase the Taxable Wage Base. We recommend the Legislature increase
the taxable wage base from $7,000 to $46,800, tying the taxable wage base to the amount of
UI benefits a worker can actually receive ($450 per week). Taxing this level of earnings means
no taxes would be paid on wages that are not covered by UI. This taxable wage base level
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would place California among the ten states with taxable wages bases above $40,000 and all
other Western states. While necessary, this step alone would not be sufficient to address the
state’s solvency problems.
• Redesign Employer Tax Rates Using Standard Rate and Reserve-Building Rate.
Following federal guidelines, we recommend the state adopt a simple, robust UI tax structure
comprised of a standard tax rate and a reserve-building tax rate. The standard tax rate would
cover typical UI benefit costs. The reserve-building rate would help the state build up a robust
reserve that can be drawn down during recessions. Under current conditions, the standard
tax rate would be 1.4 percent and the reserve-building rate would be 0.5 percent, for a total of
1.9 percent UI tax rate applied to our proposed $46,800 taxable wage base.
• Transition to Experience Rating System with Fewer Downsides. We recommend the
Legislature transition to a new experience rating system that bases employers’ tax rates on
increases or decreases in their employment, rather than an exact accounting of their former
workers’ UI costs (as the current system operates). This approach would continue to reflect,
indirectly, employers’ costs to the UI system because business that reduce employment
tend to have higher UI usage. Thus, this alternative approach maintains the policy goals of
experience rating but does not suffer from the main downsides of the current system.
• Refinance the Federal Loan With Shared Participation Between Businesses and the
State. The outstanding federal loan complicates the state’s efforts to fix its broken UI financing
system: as long as the federal loan remains outstanding, even an improved tax system would
probably not be able to build reserves ahead of the next recession. To address this, and in
acknowledgment of the unique nature of the pandemic that caused the significant UI loan, we
outline a shared approach to refinancing the federal loan. This would involve two equal parts:
(1) a revenue bond paid back by employers and (2) new borrowing from the Pooled Money
Investment Account paid back by the General Fund.
Our Approach Could Still Involve Loans, but They Would Be Smaller and Less Frequent.
Our approach would help the state build reserves ahead of recessions, but does not represent
an overly cautious tax system designed to avoid federal loans at all costs. If the state adopted our
approach, there would be some years that California would run out of reserves during a recession
and require a loan from the federal government. Yet these loans would be smaller and less frequent.
For example, if California had entered the pandemic with equivalently sized reserves, it still would
have required a federal loan, but that loan would have reached $9 billion, rather than $20 billion.
As a result, our approach represents a significant improvement over the status quo, which likely
involves near-permanent outstanding federal loans for decades to come.
Magnitude of Tax Increase and New Borrowing an Honest Reflection of UI Program’s
Imbalance. The scope and magnitude of our recommendations reflect the deep problems in the
existing UI system. These include: (1) the staggeringly large and growing loan from the federal
government and (2) the fact that the system is currently running a deficit even during an economic
expansion. These are significant problems in isolation, let alone in combination. The significant
changes proposed in this report are an honest reflection of these problems. However, whether or
not the Legislature takes action, employers will soon pay more in UI taxes than they do today due
to escalating charges under federal law. Making changes now will allow the Legislature to make
strategic choices about how to repay the federal loan, while also replacing the UI financing system
with one that is simpler, balanced, and flexible.
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INTRODUCTION
California’s Unemployment Insurance (UI) now routinely outpace incoming tax contributions,
program provides temporary wage replacement to leading to a costly reliance on federal loans and
unemployed workers. In so doing, UI helps alleviate constraining the state’s options to improve the
temporary economic challenges for workers and program. This report describes the problems with
their families and also bolsters the state economy the system in greater detail, including offering
during economic downturns. Despite its importance historical context and our projections of the future.
to workers and the economy, the state’s UI program We then offer four recommendations that would fix
financing system is broken. Unemployment benefits the state’s broken UI system.
CALIFORNIA’S UI SYSTEM IS BROKEN
California’s UI Program Is Funded by Taxes enough to cover the heightened benefit costs that
and Pays Unemployment Benefits. The state’s occur during a normal recession, let alone one of
UI program is a state-federal partnership under this scale, in which about 1 in 5 California workers
which workers receive partial wage replacement would eventually receive UI benefits. By the end
if they lose their job through no fault of their own. of 2020, as shown in Figure 1, the state had
Employers pay a payroll tax on each worker to distributed $24 billion in UI benefits to unemployed
fund benefits. These payroll taxes—the tax rate workers and quickly ran through its reserves. Under
currently averages 3.5 percent on the worker’s first federal rules, states must borrow federal dollars to
$7,000 in annual wages, or about $250 per year for pay benefits when state reserves run out. Over the
each worker—are paid into the state’s UI trust fund. course of the pandemic, the state borrowed about
On average, employers pay a total
of $5 billion to $6 billion into the
fund each year. When an eligible Figure 1
worker becomes unemployed, the
Pandemic Led to Unprecedented UI Benefit Costs
state pays the workers’ benefits
(In Billions)
out of the trust fund. Unemployed
workers can receive 50 percent
$25
of their regular wages, up to a
maximum of $450 per week, for
up to 26 weeks. (Due to the $450 20
weekly benefit maximum, about
half of workers receive less than
15
50 percent of their regular wages.)
With Small Reserves, System
Experienced Massive Benefit 10
Costs in 2020. While the state’s
UI system has faced fiscal hurdles
for decades, the pandemic 5
represented an unprecedented
challenge to the system. The state
entered the pandemic with about 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022
$3 billion of reserves in the UI
trust fund. This was not nearly UI = Unemployment Insurance.
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$20 billion to keep paying benefits associated with …Which Will Continue to Grow. The state
the state’s UI program. (The federal government will eventually repay the outstanding federal
expanded benefits during the height of the loan, but not until the federal surcharge gets high
pandemic, and some of these expanded benefits enough to generate substantial contributions for
were subject to significant levels of fraud. These repayment. The outstanding loan is very likely to
fraudulent payments are not a contributor to the grow by billions of dollars over the next several
state’s outstanding loan, however.) years before the federal surcharge contributions
State Now Has $20 Billion Loan are large enough to begin making progress toward
Outstanding… Since the pandemic ended, repayment. During this period, state General Fund
employer contributions have not been large interest costs will likely be about $1 billion per year.
enough to make progress toward repaying the Concerns Over Trust Fund Solvency Have
federal loan. As Figure 2 shows, the outstanding Impeded Benefit Increases and Expansions.
loan balance has remained essentially the same In recent years, the Legislature has expressed
since late 2021. Under the federal loan repayment interest in increasing UI benefit levels. Benefits
rules, employers now face escalating federal UI were last increased in 2004 and have not been
taxes that will be directed toward repaying the adjusted for cost-of-living increases since,
loan principal. This federal surcharge—technically including through the recent period of historically
referred to as the Federal Unemployment Tax Act high inflation. The Legislature also has pursued
(FUTA) tax credit reduction—will keep increasing expanding UI coverage to workers who have
by 0.3 percent each year (up to 5.4 percent in not typically received benefits, including striking
total) until the loan is repaid. (The state’s General workers, undocumented workers, and independent
Fund customarily makes annual interest payments contractors. The imbalance in the current financing
on the loan.) The state is entering its fourth year system has stymied these efforts, however.
of repayments, and so employers will pay an For example, the Governor recently vetoed a
additional 1.2 percent federal surcharge in 2025 bill to expand UI to striking workers, citing fiscal
(equivalent to $84 per worker). challenges with the state’s UI trust fund. To move
forward with these types of
Figure 2 changes or others, the state needs
to fix the system.
State Has Yet to Make Progress
Our Approach to Fixing the
Toward Repaying Federal UI Loan
State’s UI System. Although
(In Billions)
the pandemic pushed the state’s
UI system past the breaking
$25
point, the genesis of this crisis
traces back decades—as early
20
as the 1980s. In this report, we:
(1) present the evidence showing
15
that the state’s UI financing
system is broken; (2) detail how
10
chronic insolvency in the current
system undermines some of the
5
program’s core objectives; and
(3) recommend a path forward with
State had no federal loan
2018 2019 2020 2021 2022 2023 2024 a simpler, balanced, and flexible
UI financing system.
Note: Federal loan outstanding as of December 31st each year. 2024 data is as of October.
UI = Unemployment Insurance.
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HOW DID WE GET HERE?
State UI programs are supposed to be 1984 Legislation Also Put Forth State’s
self-sufficient—that is, the system should collect Current Experience Rating System. Experience
enough funds to pay for benefits over time. This rating is a standard feature of UI and functions
means, in some years, the system will collect similarly to risk-based pricing in an insurance
more than necessary so that, during economic market. As with car insurance, for example, where
downturns, there is enough money to pay for rising premiums are adjusted based on an individual’s
benefit costs. To ensure revenues match benefits risk profile (that is, driving history), experience
over time, states enacted UI financing systems. rating aims to adjust employers’ tax rates based
These systems are comprised of three elements: on their “risk” of future layoffs. Under this idea,
(1) a tax rate “schedule” that adjusts up or down employers with a higher risk of their workers
to match revenues and benefit costs, (2) a taxable claiming UI benefits should be viewed as riskier
wage base level to which the tax rate applies, and and charged higher premiums (that is, higher UI
(3) an experience rating factor to ensure employers tax rates). The state’s 1984 legislation put forth
pay their fair share of UI costs. In this section, we the state’s current system of experience rating,
present the evidence that California’s UI financing known as a reserve-ratio experience rating system.
system is broken—that is, it is not self-sufficient Under this approach, the Employment Development
and cannot collect enough funds to pay for benefits Department (EDD), the state’s UI administrator,
over time. keeps track of each employers’ cumulative UI costs
and cumulative UI contributions since the company
Tax System Has Not
formed. When costs and contributions are equal,
Withstood the Test of Time the business’ reserve “ratio” is zero. Businesses
Tax System Dates Back to 1984. California’s with a positive reserve ratio (contributions
state-federal UI program was first enacted after higher than costs) pay a lower UI tax rate and
the Great Depression. The state’s modern UI tax businesses with a negative ratio (costs higher than
system dates back to 1984, when the state contributions) pay a higher tax rate. State law sets
instituted a new tax system to conform with federal out 38 different tax rates for businesses based on
UI changes. This legislation set the taxable wage their reserve ratio (shown as rows in Figure 3 on
base at $7,000, the minimum amount allowed the next page). When overlaid with the state’s eight
under the federal changes. (The taxable wage base statutory tax schedules (shown as columns in the
is the amount of earnings that are taxed to fund figure, which change based on the UI trust fund
benefits. That is, employers do not pay UI payroll balance), California businesses pay 1 of 304 UI tax
taxes on worker earnings above the taxable wage rate options.
base.) The legislation also created a system of tax Early Tax System Was Able to Weather First
schedules, ranging from Schedule AA to Schedule Recession. After the 1984 reforms, the state
F+. The schedule is intended to shift tax rates entered its first recession with the new UI financing
higher when the UI trust fund is depleted and lower system in place in the early 1990s. The state
when the trust fund has enough reserves. Employer was able to cover benefit costs for heightened
tax rates are lowest (Schedule AA) when the UI trust UI caseload during this recession without depleting
fund has large reserves and highest (Schedule F+) the trust fund. There are two main reasons the
when the fund has a negative balance. When first system successfully weathered its first recession.
established, the state was toward the bottom of First, the state entered this recession with a
the schedules (Schedule D)—corresponding to relatively robust reserve on hand with much of
relatively high rates—and had a sizable reserve for this reserve balance built before the tax changes
the time. enacted in 1984. Second, at the time, the state
offered more limited UI benefits (the state would
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Figure 3
State's Current UI Tax Rate Schedule
soon increase benefits, as discussed below). The average wages. In response, the state increased
tax rate schedule still had room to adjust during UI benefits in 2001. This legislation: (1) increased
this time, as intended, to keep contribution levels the maximum weekly benefit from $230 per week
sufficient to maintain an ongoing reserve. to $450 per week and (2) increased the wage
Benefit Increases Coincided With 2001 replacement rate from 39 percent to 50 percent.
Recession. Coming out of the recession in These increases were phased in between 2001 and
the early 1990s, California’s UI benefits (as a 2005. During the phase-in period, the state also
share of average wages) were the lowest in the entered the dot-com recession. These two cost
country. At the time, average benefits replaced pressures absorbed the remaining flexibility in the
roughly 20 percent to 25 percent of workers’ state’s UI tax system. As shown in Figure 4, the
state began this period in Schedule C but quickly
8 LEGISLATIVE ANALYST’S OFFICE
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moved to Schedule F+, the highest tax schedule, historically long economic expansion. In short, the
where it has remained since. F+ schedule carries insufficient tax rates to build
Tax System Had No Room to Work in the reserves, which means the state has remained
Great Recession. When the state entered the stuck at this rate schedule.
Great Recession, the UI tax system already was After Historically Long Economic Expansion,
at the maximum tax rate schedule (Schedule F+). State Entered Pandemic With Minimal
Although the state had a small reserve leading up Reserves. The state entered the pandemic with
to the recession, it was not sufficient to lower the $3 billion in the UI trust fund. The pandemic
tax rate schedule. Moreover, given the reserve was resulted in a historic surge in unemployment and,
modest, it was quickly depleted as unemployment as a result, unprecedented state UI costs. The state
and benefit costs increased during the distributed a total of $24 billion in state UI payments
Great Recession. To continue paying UI benefits, in 2020—more than double the former peak from
the state borrowed $11 billion from
the federal government. From 2011
through 2018, California businesses Figure 4
paid the federal surcharge to repay
California Has Been at Maximum UI Tax Rate
the loan principal while the General
Schedule Since 2004
Fund made a total of $1.4 billion in
interest payments.
Tax Rate Schedule UI Trust Fund Reserves
After Great Recession, Tax
F+ $7
Rates Declined, Worsening
F 6
an Already Poor Position. At highest tax rate
E schedule, system
5
Although the long economic cannot build reserves
D
recovery that followed the Great 4
C
Recession should have provided 3
B
the system with an opportunity
2
A
to build reserves, experience
AA 1
rating prevented the system from
functioning as intended. The state 1985 1990 1995 2000 2005 2010 2015 2020 1985 1990 1995 2000 2005 2010 2015 2020
remained in the F+ schedule for
UI = Unemployment Insurance.
this entire period. Yet, as the state’s
economy recovered, employers’
Figure 5
experience rating reserve ratios
began to improve because fewer
Average UI Tax Rate Declined After the
workers were receiving UI benefits.
Great Recession Due to Experience Rating
In other words, paradoxically,
businesses’ improving reserve
6%
balances moved them to lower tax
rate rungs within the F+ schedule, 5
which had the effect of lowering
4
state UI tax rates, as shown in
3
Figure 5. (This occurred even as
From 2011 to 2019,
those businesses were paying 2 average UI taxes
declined from 5.4%
the escalating federal surcharge to 4.0%
1
to repay the outstanding loan.)
Statewide, these lower tax rates
prevented the state from building 1985 1989 1993 1997 2001 2005 2009 2013 2017 2021 2023
the UI trust fund reserve during this
UI = Unemployment Insurance.
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the Great Recession. (This amount does not include Why Hasn’t the State’s Tax System Worked?
payments from the temporary federal UI programs The state’s UI tax system—including its tax
that were the subject of widespread fraud.) rates, tax schedule, taxable wage base, and
Pandemic-Era Polices Exacerbated experience rating—cannot generate sufficient
Underlying Shortcomings of Tax System. employer contributions to build and maintain
During the pandemic, the Legislature passed a adequate reserves. In a well-functioning system, an
new policy to disregard pandemic benefit costs employer’s experience rating reflects their individual
when calculating employers’ experience rating tax costs to the UI program, while the tax schedule
rates. The intention was that businesses should not adjusts to ensure that the fund receives enough
face higher UI costs due to layoffs related to the contributions overall to cover benefit payments.
public-health shutdowns that were clearly outside However, in the state’s system, both mechanisms
of their control. This policy, which we refer to as have broken down. Each year, between 10 percent
“non-charging,” had the effect of substantially and 40 percent of employers reach the maximum
lowering employers’ tax rates relative to what they UI tax rate, capping their contributions despite
otherwise would have been. As shown in Figure 6, their benefit costs exceeding those contributions.
absent the non-charging policy, we estimate that Ordinarily, the tax schedule would increase when
average tax rates would have been above 5 percent trust fund reserves decline, raising contributions
rather than around 3 percent. for all employers to offset these shortfalls. But in
the current system, the tax schedule is constrained
These lower-than-expected tax rates have
and unable to rise further. As a result, the system
exacerbated the state’s long-standing imbalance
cannot accommodate these unaccounted-for costs
between benefits and contributions, contributing
or generate the reserves needed to safeguard
to the state’s current structural deficit. This is not a
against future shortfalls. This breakdown means
temporary problem. Under the state’s experience
that the experience rating system, instead of
rating system, non-charging will keep UI tax rates
ensuring higher contributions from employers with
artificially low for many years because businesses’
higher UI costs, actually contributes to lowering the
reserve ratio calculations are cumulative—that is,
average tax rate at a time when increased funding is
they weigh the businesses’ lifetime UI costs and
crucial to rebuilding reserves.
contributions—and those balances will forever
exclude the pandemic-era non-charged benefits. Comparing California’s UI System to Other
States Sheds Additional Light on Program
Imbalance. Comparing California’s
Figure 6 UI system to other states offers
another perspective on these fiscal
Non-Charging Has Resulted in Employers Paying a
challenges. Relative to other states,
Significantly Lower Tax Rate
California’s UI system:
• Pays Relatively Low Benefits,
Tax Rate Without Non-Charging Yet Has High Total Costs. While
6%
California’s UI program provides
5
lower weekly benefits relative to
Actual Tax Rate Paid
4 wage levels than almost every
other state, the program tends
3
to pay benefits for a slightly
2
longer-than-average duration
1 and to a larger-than-average
caseload (see Figure 7).
1985 1989 1993 1997 2001 2005 2009 2013 2017 2021 In part, this is due to structural
elements of the state’s economy:
unemployment tends to be
10 LEGISLATIVE ANALYST’S OFFICE
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slightly higher in California than elsewhere. • Has a Below Average Tax Burden. Despite
Additionally, although the state’s benefit many employers paying the maximum UI
levels are low relative to state wages, wages tax rate, the state’s UI tax burden is below
in California are among the highest in the average compared to the rest of the United
country. This means that absolute weekly States. Even at the state’s maximum tax rate
benefit amounts remain higher than average. of 5.4 percent, when offset by the state’s low
As a result of these dynamics, the state’s UI taxable wage base, employers’ tax payments
program has higher-than-average total costs. are comparable to the national average.
For example, in 2023, California employers
Figure 7
Comparing California's UI Benefit Program With Other States
Average Weekly Benefit as a Share of Average Weekly Wage
60%
50
40
30
20
10
HIMTUT IA VTNDORSDKY IDWYWAMNNMKSMECOWVOHMANENVNJOKRI PA IL TXUSCTWIAR IN MIMDSCGADENHVAAZMOMSNCNYALAKCALATNFLDC
Average Duration (Weeks)
20
18
16
14
12
10
8
6
4
2
NJCANYMDDEMAAKNMDCOR ILMNTXLAUS RIWAMENVAZPACTKYSDWVOHHICOMTUTWYOKMSTNNDMOWI MI VTNEVA INSCNHAR IA IDNCGAFLKSAL
Share of All Workers Who Receive UI Each Year
8%
7
6
5
4
3
2
1
RI NJCACTMAMNPANYWAHI ORVT ILWVAKMI NV IA ID USMEMTWINMWYCONDTXDEDCOHGAIN UTMOMDSCAZAROKKSLAALNETNMSFLVANHNCKYSD
UI = Unemployment Insurance.
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contributed 0.33 percent of their employees’ As such, the state’s only path to repaying the loan is
total wages toward UI, on average. This is through the federal surcharge that will continue to
somewhat lower than the national average ramp up until the loan is repaid. The state’s loan is so
(among U.S. states) of 0.47 percent. significant that it is likely to remain outstanding, and
the federal surcharge in place, for at least another
When compared to other states, California’s
decade. Figure 8 shows how this would play out
UI system combines high total costs with a
if contributions and benefits continue to track with
below average tax burden. Unsurprisingly, this has
historical trends over the next two decades. As the
resulted in an imbalanced UI system.
figure shows, we do not expect the state to achieve
Going Forward, Imbalance solvency without the federal surcharge.
Expected to Worsen
Figure 8
Administration Forecasts
Continued Structural Deficit State Not Expected to Achieve Solvency
for Next Several Years. Both the Without Federal Surcharge
administration and our office expect
(In Billions)
the UI trust fund to run annual
operating deficits over the next
$20
several years. The administration’s
Federal Surcharge Contributions
forecast, which assumes a steady 18
economy, estimates deficits of a bit 16
under $1 billion through 2025. Our 14
assessment, which examines many
12
potential future paths for the state’s Benefits
10
economy, similarly finds deficits
8
are very likely to persist regardless
6
of the trajectory of the economy, State-Only Contributions
with an average outcome yielding 4
deficits of around $2 billion per year 2
for the next five years. This outlook
is unprecedented: although the 2023 2025 2027 2029 2031 2033 2035 2037 2039 2041 2043
state has, in the past, failed to build
robust reserves during periods of Trust Fund Balance (In Billions)
economic growth, it has never before
$5
run persistent deficits during one of
these periods.
With Imbalance, Federal
-5
Surcharges Are State’s Only Path
to Repay Federal Loan. The state’s -10
UI system already has a significant
-15
outstanding loan owed to the federal
government—currently $20 billion— -20
and these projected deficits will only
-25
add to that balance. Not only will
the state’s tax system fall short of -30
repaying that loan, the balance is
-35
set to grow due to the ongoing gap
2023 2025 2027 2029 2031 2033 2035 2037 2039 2041 2043
between contributions and benefits.
12 LEGISLATIVE ANALYST’S OFFICE
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State Tax System Cannot Build Reserves the pandemic-era loan before the next recession,
Ahead of Next Recession. The federal surcharge little or no reserves would be on hand at the start of
is designed to temporarily increase employer that downturn.
contributions to repay the federal loan, and it drops Loans Will Become a Permanent Feature of UI
to zero once the trust fund balance reaches zero and a Major Ongoing State Cost. Although federal
(meaning the loan has been repaid). The federal law intends the UI program to be self-sufficient, it
surcharge, therefore, cannot help the state build also prohibits states from using UI trust funds to
reserves. As a result, the state’s UI tax system pay the interest costs associated with a UI loan.
is now stuck in an insolvency cycle. Each time California has customarily paid these costs with the
businesses repay the federal loan relying on the General Fund, although some interest costs could,
federal surcharge, their state UI contributions will in theory, be covered by other state funds. Either
again fall short of covering benefits. Once this way, UI loan interest costs are paid by a broad base
occurs, the state will need to once again turn to of California taxpayers, rather than employers.
federal loans to cover normal, annual program Over the next decade, these interest costs will
costs with no opportunity to build up much in be significant, with the state’s General Fund likely
reserves. Given that a recession is likely to occur paying around $1 billion per year. This will become
in the next decade, California will almost certainly a near-permanent feature of the state’s UI program
enter the next recession with a federal loan and a major ongoing cost for state taxpayers.
outstanding. Even if the state manages to repay
FINANCING ISSUES ALSO UNDERMINE
SOME OBJECTIVES OF THE PROGRAM
While the biggest problem with the state’s would be $765 today. This means that California’s
broken financing system is a failure to fulfill its maximum benefit has, in real terms, fallen by nearly
fundamental purpose—sustainably funding half over the last two decades.
unemployment benefits—this system also has California’s Benefits Meet Federal Standard
several other drawbacks that undermine core for Only Half of Workers. The UI program is
objectives of the program. Specifically: (1) state intended to replace half a worker’s wages for
benefits do not keep pace with inflation or meet the 26 weeks. A worker will receive the maximum
federal standard for wage replacement; (2) although weekly benefit if they make at least $900 per week
ensuring broad and equitable access is a legislative or $46,800 per year. Workers who make more
priority, the tax system depresses take-up in than this amount will receive less than half of their
the program; and (3) although one goal of the UI earnings in UI benefits. When the current benefit
system is to stabilize employment, California’s UI levels were enacted in 2004, a minority of workers
tax system deters hiring of low wage workers. We in California—about 30 percent—had wage income
review these issues in this section. greater than this level. Today, it is about 50 percent.
While it is reasonable to expect that some workers
Benefits Do Not Keep Up With Inflation
would make too much money for UI to replace half
or Hit Wage Replacement Target
of their earnings, California’s benefit levels only
California’s Benefits Are Not Indexed to meet the federal wage replacement standard for
Inflation. UI benefits increase with income, but the half of the state’s workers.
maximum amount a worker can receive is $450 California’s Wage-Adjusted Average Benefit
per week—a level set in legislation passed in 2001. Is Near the Bottom of U.S. States. In unadjusted
If this benefit level had been adjusted for inflation, dollar terms, at $380 per week, California’s average
the state’s maximum weekly benefit amount weekly benefit rank around the middle of U.S.
www.lao.ca.gov 13
AN LAO REPORT
states. However, wages are higher in California Depresses Take-Up
than they are in most other states. As a result,
Less Than Half of Unemployed Workers
California’s average weekly UI benefits as a share
Receive UI Benefits. According to federal
of average weekly wages rank near the bottom, as
program reporting, each year about 40 percent
shown in Figure 9.
of unemployed workers in California receive
Although Benefit Increases May Be unemployment insurance (this is the state’s take-up
Warranted, Changes Are Unworkable Under rate among all unemployed workers). Some
Current System. The state’s benefit levels are unemployed workers are not eligible for UI for
low compared to other states, benefits meet wage various reasons, so the federal tally understates
replacement standards for only half of workers, take-up among eligible unemployed workers. In
and benefits have not kept pace with inflation for relative terms, California’s take-up rate is high when
the past two decades. Amid this bleak backdrop, compared to other states. However, in absolute
the state’s UI system is insolvent and even minimal terms, and as described in the nearby box, the
benefit adjustments are unworkable. A functioning state’s take-up rate is not particularly high and thus
UI tax system should, at a minimum, have the many eligible workers do not apply for or receive
capacity to fund the state’s current benefit levels benefits. The four most common reasons why
and provide enough flexibility to allow those eligible workers do not apply for UI include: (1) they
benefits to be inflation-adjusted over time. The did not think they were eligible, (2) they expected
state’s current financing systems falls far short of to get a new job soon, (3) they expected their
this modest standard. employer to rehire them soon, or (4) their employer
told them they were not eligible.
Current Tax System Creates
Figure 9 an Incentive for Employers
to Limit UI Costs. Under the
California UI Benefit Levels Now Among Lowest in U.S.
state’s experience rating system,
Average Weekly Benefit as a Share of Average Weekly Wage
individual employers’ tax rates
increase when their former
70%
employees collect UI benefits.
Among other goals, this was
60 intended to provide a financial
incentive for employers to limit
UI costs by discouraging the
50
employer from laying off workers.
However, the same incentive
to limit layoffs also leads some
40
employers to appeal their workers’
UI claims, even valid ones, and
30 provides no encouragement for
employers to assist former workers
in accessing benefits. These
20
incentives prompt some employers
to hire third-party companies
to manage the employers’ UI
10
claims, including representing the
employer at appeals, to limit UI
costs. As a result, many workers
1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020
believe they are ineligible (or are
UI = Unemployment Insurance. told they are ineligible) and are less
likely to apply for UI benefits at all.
14 LEGISLATIVE ANALYST’S OFFICE
AN LAO REPORT
California’s Unemployment Insurance (UI) Take-Up Rate in Context
State’s Take-Up Rate Above Average When Compared to U.S. On average across
all states, about 30 percent of unemployed workers receive UI benefits. In California, about
40 percent of all unemployed workers receive UI benefits—ranging from 35 percent to 50 percent
over time—giving California the 10th highest take-up rate nationally among all workers. However,
many unemployed workers are not eligible for UI benefits. This includes, for example, workers
who voluntarily left their jobs or were dismissed for misconduct. Nationally, take-up among this
smaller group—eligible unemployed workers—has recently been measured close to 70 percent.
We do not have a similar figure for California specifically.
UI Take-Up Rate Is In-Line With Other State and Federal Benefit Programs. The national
UI take-up rate among eligible unemployed workers is roughly similar to estimated statewide
take-up rates in other programs. These include the state’s food assistance program (CalFresh,
77 percent take-up rate), the state’s cash assistance program (California Work Opportunity and
Responsibility to Kids [CalWORKs], 60 percent), and the federal tax credit for low income tax filers
(the federal Earned Income Tax Credit, 80 percent). These take-up rates, including the estimate
for CalWORKs produced by our office in 2021, are calculated using different methodologies and
so may not be exactly comparable. They nevertheless represent a useful comparison to provide
additional context for the state’s UI program.
Moreover, some employers dispute all UI claims, ultimately bears the cost of the tax and therefore
regardless of validity, which might also result in is more important for policymaking. The economic
some eligible workers not receiving benefits. incidence of the UI tax can mainly fall on either (or
Fewer Eligible Workers Apply for UI at both) employers and workers. In general, when the
Businesses That Regularly Appeal Claims. incidence mostly falls on the employer, it results in
Recent research conducted in Washington increased costs for them. Employers can respond
State, with a similar experience rating system to these cost increases by reducing employment
as California, shows that some businesses limit (for example, through reduced hiring or increased
UI take up by appealing a large share of claims layoffs) or by reducing profits. When it mostly falls
or discouraging workers from claiming UI. The on the employee, it has the effect of reducing
researchers found that fewer workers apply for UI wages. These effects can vary in size.
when their former employer regularly appeals UI Empirical Evidence Suggests Payroll Taxes
claims—an apparent “deterrent effect.” Overall, Generally Reduce Employment, Especially of
the underlying incentive in the state’s current Low Wage Workers. The best available empirical
experience rating system to limit UI costs works evidence suggests that the burden of payroll taxes
against the state’s objective to maximize take-up mainly falls on employers and that increases in
among eligible unemployed workers, although the those taxes result in reductions in employment.
extent of this effect is unknown. That research also has found these effects, while
small, are especially noticeable among low-wage
Deters Hiring of Low-Wage Workers
workers. This is because payroll taxes owed
Economists Focus on the “Economic on behalf of these workers are relatively large
Incidence” of Taxes. Tax incidence refers to compared to their overall wages.
who bears the burden of a tax. Tax incidence
California’s UI Tax Essentially Operates Like
can take two forms: economic and legal. “Legal
an Employment Tax. California’s low taxable wage
incidence” is simply who initially pays the tax. In
exacerbates this effect. Employers pay UI taxes on
the case of UI taxes, it is always the employer.
the first $7,000 of each worker’s earnings, but the
Economic incidence refers to the entity that
vast majority of workers earn more than $7,000 in
www.lao.ca.gov 15
AN LAO REPORT
each job annually. As a result,
Figure 10
employers pay the same amount in
UI taxes on behalf of basically every Illustrative Taxes
employee in the state, regardless
of how much that employee earns.
A Business Employing…
This creates a once-annual cost
Ten Data Ten Minimum Wage
on employers applied to each Scientists Workers
new hire. As Figure 10 shows Each worker’s salary $150,000 $34,000 T fir a s x t r $ a 7 te ,0 a 0 p 0 p o lie f s e v t e o ry
Business’ total payroll costs 1,500,000 340,000 employee’s annual salary.
with some illustrative numbers,
Total taxable payroll $70,000 $70,000
this employment tax raises the Tax rate 3% 3%
cost of adding a new employee Total UI taxes paid $2,100 $2,100
UI Taxes as a Share of Payroll 0.14% 0.62%
to a business and that cost is
proportionately higher for a low
wage worker than a high wage
taxes and means the state’s current tax system
worker. This likely further exacerbates the already
could be unnecessarily deterring hiring of lower
existing negative employment effects of a payroll
wage workers.
RECOMMENDATIONS
In Light of Challenges, State’s UI Tax System recommendations, we started with the best
Needs Full Redesign. A UI tax system should practice principles outlined in the U.S. Department
generate sufficient contributions to: (1) cover of Labor (DOL) report Guidelines for the
typical benefit costs each year and (2) build up Construction and Analysis of State Unemployment
a reserve during expansions that can be drawn Insurance Financing Structures. However, our
down during recessions when benefit costs exceed recommendations are customized to California’s
contributions. In this section we recommend a unique UI system. We describe each of our
path forward to fix the state’s broken UI system recommendations below.
and achieve these goals,
replacing it with one that is
Figure 11
simpler, balanced, and flexible.
Recommended Approach to Fix State’s UI System
In addition, while the focus of
these recommendations is on
9
solvency, we have also aimed Increase the Taxable Wage Base. Increase the taxable wage base from
to mitigate each of the three $7,000 to $46,800.
other issues that undermine 9
Redesign Employer Taxes. Adopt a simple, robust UI tax structure
some of the core objectives of comprised of a standard rate and a reserve-building rate.
the program.
9
Rethink Experience Rating. Transition to a method of experience rating
Recommended Approach.
based on each business’ changes in employment, rather than their individual UI
Our recommended approach, contributions and benefits.
as summarized in Figure 11,
9
has four parts: (1) increase the Refinance the Outstanding Loan. Repay the outstanding federal loan
immediately by using new borrowing, split evenly between: (1) a revenue
taxable wage base, (2) redesign
bond to be repaid by employers, and (2) Pooled Money Investment Account
employer tax rates, (3) rethink borrowing to be paid by the state’s General Fund.
employer experience rating, UI = Unemployment Insurance.
and (4) refinance the federal
loan. In putting together these
16 LEGISLATIVE ANALYST’S OFFICE
AN LAO REPORT
INCREASE THE discuss in the nearby box. That is, we view raising
the taxable wage base as a necessary but not
TAXABLE WAGE BASE
sufficient condition to fixing the state’s broken
Recommend Substantially Increasing the
UI system.
Taxable Wage Base. We first recommend the
Recommend Tying Taxable Wage Base to
Legislature substantially increase the state’s
Maximum Weekly Benefit Level. Although there
taxable wage base, which is currently set to
are clear arguments to substantially raise the
the federal minimum of $7,000. Nationwide, the
taxable wage base, it has no single “correct” level.
average taxable wage base is around $21,000.
One reasonable approach would be to connect
States at the top of the distribution include other
the state’s taxable wage base to the amount of
Western states: Washington ($67,600), Hawaii
UI benefits a worker can actually receive. Under
($56,700), Oregon ($50,900), and Alaska ($47,100).
this idea, an employer would not pay taxes on a
Substantially raising the state’s taxable wage
worker’s income in excess of the income on which
base would: (1) improve solvency and (2) mitigate
a worker is eligible for wage replacement under UI.
the disincentive for businesses to hire low wage
In other words, no taxes would be paid on wages
workers. However, raising the taxable wage base,
that are not covered by UI.
even substantially, would not in and of itself be
enough to dependably result in solvency, as we
Why Isn’t Raising the Taxable Wage Base Enough to Fix the Financing
Problem?
Tax Rates Under Experience Rating Based on Employer Contributions and Benefits.
Under the state’s experience rating system, employers’ annual tax rates are based on both how
much that employer has contributed to the system and how much in benefits are attributable to
its previous employees for all previous years. This means employers’ tax rates are sensitive to
two factors: their individual contributions made and benefits paid. That is, employers’ tax rates
will increase when benefits paid out to their former employees increase and decline when their
contributions to the system increase.
Tax Rate Automatically Declines in Response to Policy Changes That Raise
Contributions. A tax rate that decreases in response to higher contributions made and
increases in response to higher benefits paid makes intuitive sense throughout an economic
cycle. For example, during a recession when unemployment rises, benefit payments rise, and
therefore employers’ tax rates also will tend to rise, resulting in the system collecting more money.
These relationships are less intuitive, however, in response to policy changes. Specifically, if the
Legislature increases the state’s taxable wage base, it will result in higher employer contributions,
but this in turn will result in an automatic reduction in employers’ tax rates in the following
year. These lower tax rates result in lower contributions, thereby eroding the effect of the initial
policy change. Our estimates suggest this offsetting effect is substantial and much larger than
previously understood.
Even a Substantial Increase in the Taxable Wage Base Would Not Dependably Result in
Solvency. As a result of these factors, increases in contributions that result from increasing the
taxable wage base would lessen the fund’s annual operating deficits, but would not dependably
result in solvency. For example, even if the state raised the taxable wage base to $50,000, it
would continue to routinely rely on federal loans—and the associated federal surcharge—to pay
benefits. In our view, changes to tax rates are therefore also necessary.
www.lao.ca.gov 17
AN LAO REPORT
At Current Benefit Levels, Taxable Wage Base the Legislature change statute to explicitly tie the
Would Correspond to $46,800. Assuming the taxable wage base to maximum weekly benefits
$450 maximum weekly benefit and a 50 percent going forward. This would mean that any future
wage replacement rate, the state would adopt a changes to benefits would automatically trigger
taxable wage base of $46,800. Figure 12 shows an increase to the taxable wage base. Further, we
how the state’s current taxable wage base and our suggest the Legislature consider annually adjusting
recommendation compare to other states. If the both the taxable wage base (and maximum weekly
state raised the maximum weekly benefit amount, benefit amounts) for inflation, so that benefits
the corresponding taxable wage base would also maintain their purchasing power.
need to increase. To that end, we recommend
REDESIGN
EMPLOYER TAX RATES
Figure 12
Recommend Redesigned
Proposed Increase to Taxable Wage Base
Employer Tax Rates. We
Would Position California With Many Other States
recommend the state adopt a
simple, robust UI tax structure
California
Florida composed of a standard tax rate
Tennessee
and a reserve-building tax rate.
Louisiana
Alabama In this section, we describe the two
Arizona
Arkansas tax rates, how they work together,
Virginia
Maryland and present the tax rates that
District of Columbia
Nebraska would go into effect should these
Ohio recommendations be adopted. (All of
Texas
West Virginia the figures in this section assume a
Georgia
Indiana taxable wage base of $46,800.)
Michigan
Pennsylvania Standard Rate to Fund Typical
Missouri
Delaware UI Costs. Federal guidelines
Kentucky
recommend that states set a
Maine
New York standard, base UI tax rate to
Illinois
Vermont fund typical UI benefit costs. We
Kansas
Mississippi recommend the state define this base
New Hampshire
cost by first calculating the average
South Carolina
Wisconsin number of weeks of UI benefits paid
Connecticut
Massachusetts to covered employees over time—this
South Dakota
Colorado accounts for both duration of benefits
Oklahoma
and take-up rate. Over the last ten
Rhode Island
Wyoming years, the UI program each year
North Carolina
New Mexico has paid an average of 1.4 weeks of
Iowa
Minnesota benefits per covered employee. (We
Nevada
recommend excluding 2020 from
Montana
North Dakota this calculation given the abnormality
New Jersey
Utah of UI costs that year.) Then, we
Proposed California Level
Alaska multiply this rate by current covered
Idaho
employment and current average
Oregon
Hawaii weekly benefit amounts to define a
Washington
“typical benefit cost year.” This is
10,000 20,000 30,000 40,000 50,000 60,000 $70,000
currently about $7 billion.
18 LEGISLATIVE ANALYST’S OFFICE
AN LAO REPORT
• Standard Rate Would Be 1.4 Percent. Once the state reaches its reserve target,
Under current conditions, but assuming our the reserve-building rate would turn-off and
proposed taxable wage base of $46,800, the employers would only pay the standard rate.
standard UI tax rate would be 1.4 percent.
Total UI Tax Rate Would Be 1.9 Percent
(To raise the same amount of money under
Under Current Conditions. Combining the state’s
the state’s current taxable wage base of
standard tax rate (1.4 percent) with the temporary
$7,000, the standard tax rate would need to
reserve building tax rate (0.5 percent) would yield
be 5 percent, well above the state’s current
a total UI tax rate of 1.9 percent (see Figure 13).
tax rate of 3.5 percent.) This rate would
For any worker making more than our proposed
be updated annually, adjusting gradually
taxable wage base ($46,800 per year), their
to changes in the state’s long-term UI
employer would pay around $900 per year under
benefit costs.
this total UI tax rate. For a worker making less—say,
Reserve-Building Rate to Prepare for Next for example, minimum wage—employers would pay
Recession and Minimize Federal Loans. around $600 per year under this rate.
Following best practices, the state’s UI tax system
should also include a temporary state surcharge Figure 13
tax rate, known as the reserve-building rate, to
Recommended UI Average Tax Rates
build up and maintain modest reserves that can
Assumes Taxable Wage Base of $46,800
be drawn down during recessions when benefits
exceed typical contribution levels. Federal officials
Standard rate 1.4%
recommend targeting a reserve amount equal to
Reserve-building rate 0.5
the average of the three highest benefit cost years
Total 1.9%
over the past two decades. In our recommended
Note: These rates reflect current conditions and would go up or down
approach, we again use the “average number of in future years, depending on the UI Trust Fund’s condition. (In some
years, for example, the reserve-building rate would drop to zero.)
weeks of UI benefits paid to covered employees”
UI = Unemployment Insurance.
calculation described earlier. To determine the
reserve target, we take the average of three
highest years of this measure over the last 20 years
RETHINK EMPLOYER
(excluding 2020) and again update for current
employment and benefit levels. This gives a current EXPERIENCE RATING
reserve target of around $15 billion. In other words, Recommend State Transition to an
the state would need $15 billion in reserves today to Experience Rating System With Fewer
cover one year of typical recession-level UI costs. Downsides. As discussed above, California’s
(The box on the next page describes the rationale current system of experience rating has created
behind this recommendation.) Under the federal unintended problems, including undermining
guidelines, when trust fund reserves are below this the system’s solvency and depressing take up.
target, states should attempt to build this reserve We recommend the Legislature transition to a
over a three- to five-year period. similar method of experience rating that has
fewer downsides. This section describes our
• Reserve-Building Rate Would Be
recommendation for an alternative system.
0.5 Percent. Under current conditions, but
assuming our proposed taxable wage base Recommend Setting Employers’ Tax
of $46,800 and assuming the state aimed Rates Based on Increases or Decreases in
to reach the reserve target in five years, the Employment. The state’s current experience
reserve-building tax rate today would be rating system is accounting based: it scores
0.5 percent. (To raise the same amount of each employer according to how much they have
money under the state’s current taxable wage paid into and out of the UI trust fund, requiring
base of $7,000, the reserve-building tax rate EDD to trace every UI claim back to the worker’s
would need to be an additional 1.9 percent.) former employer and maintain these records in
separate “accounts” on behalf of each employer.
www.lao.ca.gov 19
AN LAO REPORT
A Balanced Approach to Building Reserves
Our recommended approach would help the state build robust reserves ahead of recessions,
but does not represent an overly cautious tax system designed to avoid federal loans at all
costs. While the state could pursue a more cautious approach, one in which the Unemployment
Insurance (UI) program avoids federal loans entirely, doing so would require the state to institute
even higher employer payroll taxes. We take a more balanced approach. Should the state adopt
our approach, California could run out of reserves during some recessions and require a loan
from the federal government to pay for UI benefits. In these cases, the state’s reserve cushion
would cover most UI costs, meaning the state would depend only minimally on federal loans.
Relative to the current system, our approach would reduce the chances loans are needed and
diminish their size. For example, if California had had equivalently sized reserves going into
the Great Recession, it still would have required a federal loan, but that loan would have been
$5 billion rather than $11 billion. Similarly, had the state entered the pandemic with a similar
reserve target ($14 billion in that case), the total federal loan would have reached $9 billion,
rather than $20 billion.
We recommend the state take a broader approach system does not suffer from the two main
to experience rating: assign tax rates to employers downsides of the state’s current experience rating
based on increases or decreases in their system. Tax rates would not automatically adjust
employment in recent years. Although no states downward in response to higher contributions
currently have this precise experience rating model (thereby undermining solvency efforts). And the new
in place, it is similar to the payroll decline system system would remove the incentive for employers
in Alaska, which assigns employers’ tax rates to dispute valid claims. This is because, under our
based on whether or not their payroll declined in experience rating system, an individual UI claim
previous years. would have no impact on the business’ tax rate.
How Our Alternative Would Work. Under our Our alternative system could also be less costly for
recommended system, the state would assign EDD to administer.
each employer a rating based on the change in that Would This System Make It Harder for EDD
employer’s number of employees in the previous to Prevent Fraud? One potential concern with this
12 quarters. (The rating would adjust to account for new approach is that employers might be less likely
seasonality.) Employers with the largest increases to cooperate with EDD’s fraud detection efforts via
in employment would pay the lowest tax rates. employer verification because they no longer have
Employers with the largest employment declines a strong incentive to participate. While this is a
would pay the highest tax rates. Each year, EDD valid concern, employer cooperation and fraud do
would set tax rates that correspond to each rating not appear to be substantial concerns in Alaska,
to ensure the average tax rate is equal to the which has a similar experience rating system.
standard rate. Experience rating would not affect In Canada, where the national UI program includes
employers’ reserve-building rate. no experience rating, employers nevertheless
Recommended Improvement Maintains cooperate with officials to prevent fraudulent
Policy Goal of Experience Rating, but Without claims from going forward. Further, although
Main Downsides. This experience rating employer verification plays an important role in
method would continue to account, indirectly, fraud detection, that role has been minimized
for employers’ individual costs to the UI system. recently due to the changing nature of UI fraud.
Businesses that reduce employment tend to have Today, the most common UI fraud scheme
higher UI usage. Those same businesses also involves identity theft—that is, when someone
would pay higher taxes. Yet this recommended gains access to a person’s identity information
20 LEGISLATIVE ANALYST’S OFFICE
AN LAO REPORT
and uses the information to file a claim—rather the costs of paying off the federal loan between
than workers seeking benefits which they are not businesses and the taxpayers:
eligible to receive. Identity theft must be managed
• Revenue Bond Paid Back by Employers.
by EDD itself and these efforts will be enhanced by
First, the state would issue a revenue bond
EDDNext, a new information technology project to
for approximately $10 billion to be repaid by
manage the UI program. That being said, if fraud
employers. (A similar strategy has been used
remains a concern, the Legislature could implement
by other states—including Colorado, Michigan,
other mechanisms to require or strongly incentivize
Pennsylvania, and Texas—which used loans
employers to participate, such as penalty tax rates
like these after the Great Recession.) We think
levied only on employers who refuse to participate
it’s reasonable to assume such a bond could
in EDD’s fraud detection communications.
be issued with a 15-year maturity at a fixed
interest rate of around 5 percent. In addition,
REFINANCE THE FEDERAL LOAN
to attain the highest rating—and lowest
Even Under Improved Tax System, State Must interest rate—the state would need to raise
Pay Off Federal Loan Before Building Reserves. revenue in excess of the minimum debt service
The currently outstanding federal loan complicates (this is called a coverage ratio). Assuming
the state’s efforts to fix its broken UI financing a coverage ratio of 1.25, the total cost to
system: as long as the federal loan remains businesses (on top of the tax rates above)
outstanding, even an improved tax system would would be around $1.2 billion annually (roughly
probably not be able to build reserves ahead of the $80 per covered employee). Businesses would
next recession. This is because new contributions make bond payments with a flat surcharge tax
under the improved tax system would first go rate on top of their UI payroll taxes. As long
toward paying off the loan rather than building as the bond is repaid using payroll taxes only,
reserves. With this timing issue in mind, we suggest and not state tax revenues more broadly, it
the Legislature consider alternatives to repay the would not require voter approval.
federal loan that allow the state to start building
• Pooled Money Investment Account (PMIA)
reserves for the next recession immediately. We put
Borrowing Paid Back by the General Fund.
forward one approach to this problem here.
Second, the state would borrow approximately
Outstanding Loan Stems From Pandemic $10 billion from its cash resources, the PMIA.
Shutdown, Suggesting State May Have Some If this borrowing were repaid over 15 years
Responsibility for Repaying It. The unique nature and the interest rate were set to float with
of the pandemic stay-at-home period raises the the PMIA yield, the total cost to the General
question: what role does the state have in sharing Fund could be around $14 billion, or nearly
the burden of repaying pandemic UI costs? The $1 billion annually. (This is a few billion dollars
wave of UI claims in the spring of 2020 did not more, in total, than the General Fund is
stem, as UI claims often do, from cyclical business expected to pay in total interest payments on
layoffs. Instead, these claims stemmed from an the federal loan under current law.) The state
unprecedented effort to minimize the spread of the has used PMIA borrowing for some financial
virus. Together, Californians decided to temporarily arrangements in the past. While our office
prioritize public health at the expense of nearly has cautioned the Legislature against using
all in-person economic activity. One reasonable PMIA borrowing in some circumstances and
conclusion from this unique experience is that borrowing from the PMIA at this magnitude
there is shared responsibility for paying down the would involve clear downsides, we think it
outstanding UI loan, which could be achieved is reasonable to use this option in this case
through state action. where there is a fiscal benefit to the state and
Recommend a Shared Approach to businesses. The state would repay the PMIA
Refinancing Outstanding Federal Loan. Below, borrowing and associated interest from the
we outline a shared approach that would split General Fund. Importantly, this approach is
www.lao.ca.gov 21
AN LAO REPORT
only merited when paired with larger reforms Shared Approach Would Spread Out Cost
to the system. This recommendation also of Paying Off Loan and Allow State to Build
assumes the state does not have a General UI Reserves Immediately. Under our shared
Fund surplus to allocate to this purpose. If the approach to refinancing the loan, proceeds from
budget condition significantly improves before the $10 billion revenue bond and the $10 billion
the Legislature takes action on UI reform, we PMIA borrowing would immediately go to paying
would recommend using surpluses instead of off the outstanding federal loan. As a result, the
PMIA borrowing. federal surcharge tax rates employers are currently
paying (and set to pay for many years) would end.
Although We Propose an Even Split Between
The state’s UI trust fund balance would be reset to
Bond and PMIA Borrowing, State Could Move
$0 instead of negative $20 billion. Due to the longer
Forward With Different Approach. In this report,
repayment schedule and shared responsibility with
we suggest the state evenly split repayment of the
the General Fund, businesses would pay a lower
federal UI loan between a revenue bond repaid
surcharge compared to the federal surcharge
by employers and PMIA borrowing repaid by the
they would pay under current law. Alongside our
General Fund. However, there is no single, correct
proposed UI tax system changes, the state would
approach to determining this balance. If this
also begin to immediately build reserves ahead of
recommendation were adopted, the Legislature
the next recession instead of spending the next
could move forward with a different mix that
several years slowly paying off the loan before the
optimally balances trade-offs at that time.
next recession starts.
FINAL CONSIDERATIONS
Our Recommendations Would Result in Our Recommendation That the State Take on
Significant Tax Increases for Employers. In this New Borrowing Also Has Serious Trade-Offs.
report, we have recommended the Legislature In recognition of the significance of these tax
make a number of changes to the UI financing increases, coupled with the unique circumstances
system. These recommendations, taken together, of the pandemic, we also recommend the state
would have the effect of substantially increasing reduce the burden on businesses of repaying the
UI taxes paid by California’s employers. For existing loans. This recommendation requires the
example, an employer pays about $250 per year state use two new sources of borrowing: a revenue
in UI taxes per employee making minimum wage. bond, backed by businesses, and borrowing
This amount will increase to about $450 in the from the PMIA, to be repaid by the General Fund.
coming years to repay the federal loans. Under However, these recommendations have notable
our recommended approach, the same employer risks and trade-offs and so we do not make them
would pay about $700 per year in the short term lightly. New PMIA borrowing, in particular, could
while the state is building a reserve and employers involve downsides for the state, particularly if the
are repaying the revenue bond. (Employer taxes loan is not repaid before the next recession begins
would decline thereafter.) For an employee making as it reduces the state’s cash on hand both in the
any amount more than $46,800, employers’ taxes short and long term. It also limits the capacity of
would increase to around $1,000 per year. (Under the state to use the account for other purposes in
our proposed experience rating alternative, actual the future.
taxes paid by each individual employer would vary Magnitude of Tax Increase and New
above and below these averages based on their Borrowing an Honest Reflection of UI Program’s
employment track record.) Imbalance. We acknowledge that the scope and
magnitude of this package of recommendations—
22 LEGISLATIVE ANALYST’S OFFICE
AN LAO REPORT
including sizeable increases in state payroll will soon pay substantially more in UI taxes than
taxes as well as new forms of borrowing—are not they do today. The reason for this is the state’s
insignificant. However, they also reflect the deep significant UI loan, which will need to be repaid
problems in the existing UI system. These include: with an annually escalating federal surcharge
(1) the staggeringly large and growing loan from the that is likely to reach at least 3 percent and could
federal government and (2) the fact that the system climb as high as 5.4 percent. (This will be levied
is currently running a deficit even during a period on top of the state’s tax rate, which we expect to
of economic expansion. These are significant increase to around 5 percent in the coming years
problems in isolation, let alone in combination. under current law.) Compared to the state’s recent
They also are not temporary or short term, rather approach—wherein artificially low tax rates left the
they are likely to compound in the coming years. UI trust fund insolvent—these unavoidable higher
Looking ahead, these challenges threaten to erode tax contributions will be jarring cost increases for
the UI program’s long-standing goals to provide employers. However, employers will pay higher
some temporary cushion for unemployed workers UI taxes one way or another—either through a
and their families and to help stabilize the broader streamlined state tax system or through escalating
economy by supporting consumer spending during federal charges. Making changes now will allow the
economic downturns. Legislature to make strategic choices about how to
State’s Employers Will Pay Higher UI Costs repay the federal loan, while also replacing the UI
One Way or Another. Even if the Legislature does financing system with one that is simpler, balanced,
not adopt our recommended solutions, employers and flexible.
www.lao.ca.gov 23
AN LAO REPORT
LAO PUBLICATIONS
This report was prepared by Chas Alamo and Ann Hollingshead 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.
To request publications call (916) 445-4656. This report and others, as well as an e-mail 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,
California 95814.
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