Unemployment insurance taxes fund a social insurance program jointly operated by the federal and state governments. Employers pay taxes into the unemployment insurance (UI) program to finance benefits for workers recently unemployed. Tax rates vary based on factors like the health of a state’s UI fund and a business’s layoff history. All 50 states and the District of Columbia levy UI taxes through complex, variable-rate systems.
How Are Unemployment Insurance (UI) Taxes Structured?
Employers pay UI taxes to the federal and state governments.
Federal unemployment taxes require employers to pay a 6 percent tax on the first $7,000 of wages paid to employees each year. But the effective tax rate can be as low as 0.6 percent, because employers that pay their state-level unemployment taxes on time can receive a credit of up to 5.4 percent against their federal unemployment taxes.
State-level UI tax rates are based on state-determined rate schedules. The rate for any particular business depends on the business’s experience rating: businesses with the best experience ratings will pay the lowest possible rate on the schedule while businesses with the worst ratings pay the highest.
Experience ratings are based on the history of unemployment claims against a business. Details vary from state to state, but the intention is to charge businesses with frequent layoffs more and charge businesses with better track records less. New businesses pay a new employer rate until accumulating enough history to calculate an experience rating. Rates and surtaxes are also influenced by the health of the state’s UI trust fund, among other factors.
UI tax liability depends on a business’s tax rate and a set amount of wages, or a taxable wage base. States can determine their own taxable wage base as long as it is at or above the federal minimum of $7,000. The combination of a state’s tax rate schedule and taxable wage base determines how large each employer’s unemployment tax liability will be.
What Unemployment Insurance Benefits Do States Provide?
States differ in the number of weeks of benefits they provide to unemployed individuals. With a few exceptions, states generally provide between 20 and 26 weeks of benefits.
Many states recognize that certain benefit costs should not be charged to employers, including if the past employee left voluntarily, was discharged for misconduct, or refused other suitable work, among other situations. States that hold employers responsible for such expenses increase the non-neutrality of their UI taxes.
Trust Fund Solvency
When states lack sufficient funds to make unemployment compensation payments, they may borrow from the federal government under Title XII Advances. Title XII Advances are effectively loans and must be repaid. If states fail to repay the loans after an initial grace period, the federal government reduces the value of the credit employers may receive against their federal unemployment taxes by 0.3 percent per year until the loan is paid in full. Additionally, any borrowed funds accrue interest obligations in years in which a state’s trust fund balance falls below the minimum solvency levels established by the federal government.
Additional Policy Considerations
In many states, the design of UI taxes makes them unstable. When UI trust funds are flush, states trend toward their lower rate schedules, with specific rates still applying according to a business’s experience rating. When UI trust funds are low, states will trend toward their higher rate schedules. As a result, businesses face higher rates precisely when they can least afford them, and when higher employment costs may lead to further layoffs.
States can mitigate this effect by designing UI taxes that generate moderately more in good years, reducing the need to increase rates during an economic downturn. They can also ensure that charging methods reflect a business’s actual contributions to unemployment.
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