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, with employers paying different tax rates based on factors like the health of the state’s UI fund and the 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. State governments administer the unemployment insurance, and the federal government covers administrative costs and sets limited requirements.
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 those with the worst ratings pay the highest.
Experience ratings are based on the history of unemployment claims against a company. Details vary from state to state, but the intention is to charge businesses with frequent layoffs more, while imposing lower rates on companies with better track records. New businesses pay a new employer rate until enough history has been accumulated to calculate an experience rating. Rates and surtaxes are also influenced by the health of the state’s UI trust fund, among other factors.
Each business’s tax rate is applied to a taxable wage base—a predetermined amount of an employee’s wage—to determine UI tax liability. States are allowed to determine their taxable wage base, provided it is at or above the federal minimum of $7,000.
Rates can only be understood in tandem with wage bases. A 10 percent tax on a $7,000 wage base raises $700, while the same rate on a $49,800 wage base generates $4,980.
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 also 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. These advances are effectively loans and must be repaid. Each year, if states fail to repay the loans after an initial grace period, the federal government increases its effective tax rate on in-state businesses by reducing the value of a credit—normally by 90 percent—against the federal UI tax rate of 6 percent. 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 will trend toward their lower rate schedules, with specific rates within those schedules 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 to do so, 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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