An Income Tax by Any Other Name: State-Level Non-UI Payroll Taxes

All 50 states are incentivized to participate in the federal unemployment insurance (UI) program through promises of increased aid to their unemployed population that each state could not otherwise conceivably provide. Participation includes the assessment of a state-level unemployment insurance taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. on the payroll of employers. However, six states and the District of Columbia assess a state-level non-UI payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. in addition to their mandatory federal UI payroll tax.

California, Colorado, Connecticut, Massachusetts, Nevada, and Washington, in addition to the District of Columbia, levy non-UI payroll taxes, meaningfully increasing the tax burden on wage income. They differ in their administration methods, what they fund, their rates, and who they burden.

California’s non-UI payroll tax, known as the California State Disability Insurance (CASDI) tax, is currently the highest in the nation, at 1.2 percent of employees’ wages. CASDI is funded exclusively through employee-level payroll deductions, directly reducing every Californian’s effective, or take-home, wages.

Initially, the wage base was capped, consistent with a social insurance program that also caps benefits. However, on January 1, 2024, California uncapped its wage base, allowing the whole of California workers’ wages to be taxed at 1.2 percent—rendering the program much more like a general fund obligation that might otherwise be funded out of the individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. . Taken together with the state’s already high top marginal individual income tax bracket of 13.3 percent, the effective individual income tax rate for California’s highest wage earners is a staggering 14.5 percent.

The California Employment Development Department is responsible for setting the CASDI tax rate each year using the balance of the SDI Fund and the projected disbursements from that fund in the coming year.

Connecticut is another state that uses employee payroll deductions to fund its non-UI payroll tax, known as the Connecticut Paid Family Medical Leave (PFML) Program. Consistent with a social insurance program, Connecticut caps annual employee contributions. Its tax rate is 0.5 percent of eligible employees’ wages, up to the federally mandated Social Security wage cap of $176,100 (yielding the current $880.50 per employee cap). All employers with more than one employee are liable to withhold and remit PFML contributions to state coffers. Notably, Connecticut is also considering SB 1427 to expand the eligibility of the PFML program to non-certified public and private school employees, such as cafeteria workers, custodians, paraprofessionals, and bus drivers.

Colorado’s Family and Medical Leave Insurance (FAMLI) has a combined rate of 0.9 percent, split equally between employers and employees—though, economically speaking, the tax is mostly borne by the employees themselves (with the employer share borne by them in the form of lower wages). Colorado also exempts employers with fewer than 10 employees from the employer share. Colorado also caps the wage using the federal Social Security wage base (currently $176,100), yielding a maximum payment of $1,855 per year at current rates. Like California, Colorado empowered the Director of the FAMLI Division within the Colorado Department of Labor and Employment to set its FAMLI tax rate using a formula that considers the current monetary value of the FAMLI Fund. The calculated rates may not exceed 1.2 percent.

The District of Columbia, just like California, has an unlimited wage cap for its Paid Family Leave (PFL) Program. DC recently increased its contribution rate from 0.26 percent to 0.75 percent on total gross wages. It also states that employers withhold and remit the whole share of their 0.75 percent wage base. DC recognized the realities of the COVID-19 pandemic and adjusted its PFL program to only include employees who spend more than 50 percent of their time in the District. The DC Council must set the contribution rate, unlike all other state-level non-UI payroll tax administration methods which place that authority in state Departments of Labor or other agencies.

Massachusetts’ non-UI payroll tax, known as the Massachusetts Paid Family Medical Leave (PFML) Program, has a contribution rate of 0.88 percent of employee wages. The contribution rate revenues are divided between family and medical leave funds with 0.7 percent being allocated to medical leave and 0.18 percent being allocated to the family leave fund. Employers with fewer than 25 employees are responsible for only their employees’ remittance, at a combined rate of 0.46 percent. With 25 or more covered employees, the employer must remit 0.88 percent but may deduct up to 40 percent of the medical leave contribution and 100 percent of the family leave contribution from employees’ wages, yielding the 0.46 percent employee contribution. Massachusetts also pegs its wage base limit to the federal Social Security wage base of $176,100. The tax is administered through the Massachusetts Department of Family and Medical Leave, using program utilization, financial health, and other broad-based economic indicators as variables in its calculations.

Nevada is the last state that has a non-UI payroll tax, known as the Modified Business Tax (MBT). Employees are solely responsible for the remittance of this tax. Nevada has the second highest contribution rate of 1.17 percent of gross taxable wages, though the first $50,000 of each employee’s wages is exempt. (A higher rate of 1.554 percent is imposed on financial institutions.) Businesses with as little as one employee may be eligible to withhold and remit MBT revenue. Like many other states, Nevada requires its Department of Taxation to adjust the MBT contribution rate based on a few variables on a biennial basis. The variables include state revenue needs, economic forecasts, and the performance of the MBT fund. There is no cap, and in a state that otherwise lacks an individual income tax, the MBT acts in many ways as a low-rate individual income tax collected through employers rather than wage earners.

As can be seen, these six states and DC have a wide variety of administrative methods, formulas, thresholds, and rules for how they update their non-UI payroll taxes. Notably, California, Nevada, and DC have no wage base cap. This is perhaps excusable in Nevada’s case, where the tax functions like a backdoor individual income tax and benefits the state’s general fund, but it is harder to justify in California and DC, where they are intended as premiums for a mandatory insurance program. Additionally, a few states exempt small employers from an employer share, while others do not. Hawaii, meanwhile, takes a different approach, requiring businesses to provide temporary disability insurance coverage for their employees (and permitting them to deduct a certain amount from wages to defray those costs) without creating a state-based program with state premiums. The withholdingWithholding is the income an employer takes out of an employee’s paycheck and remits to the federal, state, and/or local government. It is calculated based on the amount of income earned, the taxpayer’s filing status, the number of allowances claimed, and any additional amount of the employee requests. is not remitted to the state government. Instead, it defrays costs for the employers to collect and provide unemployment insurance to their workers.

Capped wage bases—where they exist—and the dedicated purposes to which these taxes are put (save Nevada’s) distinguish most from being pure income tax add-ons, though increasingly, these taxes are a meaningful and somewhat hidden additional tax on wage income. The taxes in California and Nevada, moreover, are essentially income taxes (in California’s case, an additional income tax) by another name.

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