The States Should Quickly Reform Unemployment Insurance Programs to Prevent Economic Harm
By Brian Galle, David Gamage, Darien Shanske, & Erin Scharff[1]
COVID-19 is causing mass layoffs and related economic hardship, as well as budget crises for state and local governments.[2] This essay is part of Project SAFE (State Action in Fiscal Emergencies), an academic effort to help states weather the fiscal crisis by providing policy recommendations backed by research.[3] This essay will focus on how state governments should act to reform unemployment insurance eligibility and benefits and the taxes funding these programs.
Economic downturns are the wrong time to worry about fiscal rectitude. Yet, in the past, states have contributed to national economic misery during recessions by reducing benefits, cutting public sector jobs, and raising taxes.[4] Prudent fiscal planning in the form of rainy-day funds can help to avoid this dilemma, but no state’s rainy day fund is anywhere near large enough to weather the current storm.[5] Borrowing is a painful alternative, but where savings are not enough, it must be embraced. That is especially so now, when we face not an ordinary recession but one in which state and local governmental capacity to respond to urgent physical needs of their citizens is especially in demand. State governments must thus act quickly to seek additional funds from sources that will not exacerbate economic misery for state residents. Federal aid is especially to be sought after (as — in contrast to state governments — the federal government does not operate under balanced budget constraints). The next best source of funds is to seek the cheapest possible sources of credit.
Unemployment insurance (UI) has long been proven to be one of the government’s most effective fiscal tools against recessions.[6] At this political moment it also happens to offer states probably the cheapest source of effective credit, and a nearly limitless one to boot. Put another way, as of the time of writing, the amount of federal aid provided to the states thus far been plainly inadequate.[7] As explained below, the states can reform their UI systems so as to generate substantial additional federal support.
Unfortunately, to access this lifeline, states will have to act aggressively to set aside longstanding resistance to truly effective UI programs — that is, state governments must abandon (at least temporarily) the many needless obstacles that have accumulated over time that make it difficult for individuals to claim UI in an expedient and effective fashion. These barriers have made it difficult not only for individuals to file claims, but also costly and cumbersome for states to process them. As we write, news stories abound about states stuggling with backlogs of cases that may stretch for months at current processing rates. That is intolerable.
To be clear, we think that most (if not all) of these obstacles probably merit permanent demolition, but we would not make this perfect outcome the enemy of a good (and crucially needed) outcome in the form of temporary waivers. Thus, in this essay, we will argue that temporary waivers of many UI obstacles would be an important and urgently needed contribution to state budgets and to the national economy. With some simple steps, states can expand benefits, ease barriers to claiming, and wipe out long backlogs of individuals waiting for their claims to be processed.
It may be useful for readers first to have a brief overview of how the UI system works and is financed.[8] UI provides payments to qualifying separated workers. States control, subject to some minimum federally-set floors: the rules for what makes workers qualify to receive benefits; the systems for verifying that workers meet those qualifications; the fraction of wages that qualifying workers receive; and the rules governing how long benefits are provided.[9] The federal Department of Labor has authority to approve or reject state benefit changes if they are inconsistent with federal law, but federal law provides fairly wide latitude to states in all of these areas.[10]
State UI benefits are financed by a tax similar to federal payroll taxes (i.e., a tax imposed on worker wages up to an annual limit, which varies by state from $7,000 to about $52,000),[11] paid by employers.[12] Taxes are “experience rated,” which means that employers whose employees successfully claim benefits are taxed at a higher rate.[13] Obviously, this incentivizes employers to make benefit-claiming hard for workers.[14] The federal government also imposes a small tax on the first $7,000 of each worker’s wages, and uses this money mostly to pay any emergency benefits authorized by Congress, as well as to establish a reserve fund for states to access in crisis.
Since payments during recessions are usually inadequate to meet demand, federal law strongly incentivizes states to establish a Trust Fund account, which serves as a kind of rainy day fund for UI benefits. States that deplete their own reserves can borrow against the federal fund, which in turn can borrow against general federal revenues. Federal law requires states to begin repaying some of these loans relatively quickly — by Sept. 30 for loans taken out before May of this year.[15] Loans taken between May and September will not be due until December of 2021, although interest will accrue in the interim.[16] Federal law imposes substantial penalties if balances are not eventually repaid.[17] In the aftermath of 2008, however, Congress suspended interest payments for an additional two years.[18] Federal law now authorizes interest-free borrowing for states that hit certain Trust Fund targets,[19] and while about 60% of states were at that target in February of this year, the interest suspension lasts only until October 1.[20]
This combination of rules creates both serious dangers and also major opportunities for states. The dangers are largely dangers of stasis. The combination of experience rating, political economy, and poor program design has resulted in very significant pressure on states to minimize benefits and make them difficult to claim.[21] Adding to these intentional obstacles, the challenge of massive spikes in public need and claims filings has resulted in performance that is, predictably, four-letter-word inspiring.[22] Further, if states in fact comply with their existing experience-rating laws, they will soon begin hiking taxes to fill their empty Trust Funds, further delaying any economic recovery.
But the present opportunities to leverage the UI system for good are great as well. More than twenty states began 2020 with balances in their UI Trust Funds that were too low to meet a standard measure of adequate savings.[23] The widespread fiscal pain this entails suggests that there will almost certainly be, at minimum, a repeat of the ARRA approach of suspending interest on state debts for a substantial period, and there will likely also be considerable pressure to wipe out at least a portion of state debts to the federal Trust Fund. We say this both as a positive prediction of what we expect from the federal government, and also as a normative statement of what the federal government should do as part of making the UI program function appropriately in this crisis.
States, in short, can reasonably expect to be able to borrow at minimal interest to fund essentially unlimited UI expenditures. Further, since the state UI Trust Fund is not a state balance-sheet item in most jurisdictions, this borrowing will not affect legal balanced-budget obligations.
We should foreground some acknowledgement that this recommendation comes with some fiscal risks. Admittedly, not all bond rating agencies will overlook state UI debts, but at current interest rates the marginal cost of a slightly lower rating is modest compared to the budgetary and human payoffs. After the Great Recession, states scrambled to repay the federal government before penalty provisions kicked in, including by cutting benefits. Some states found that they could secure lower interest rates through general obligation bonds than by borrowing from the U.S. Treasury.[24] Our argument is that the nation has likely learned enough from this experience not to repeat it. Even if not, the choice between UI borrowing now, when unemployment rates are in double-digits, and slightly higher taxes in several years seems to us an easy choice.
For all of these reasons, state governments should massively increase UI spending, beginning this as soon as possible, and then devote every effort to qualifying as many beneficiaries as possible as rapidly as possible. Under the recently-enacted CARES Act, Congress provides an additional $600 per qualifying worker per benefits period payment, all fully federally funded.[25] This offers massive potential economic relief and potential stimulus to local economies, with obvious knock-on effects for revenue sources such as state and local sales taxes. Yet under current law in some states, relatively few separated workers will receive any benefits at all; for instance, in southern and mountain states fewer than one in five workers who lose their jobs typically receive UI.[26]
States should thus act immediately to remove as many obstacles to benefit claiming as possible. Ideally, states would ask employers to identify every separated worker, and automatically enroll those workers for UI benefits. If verification procedures were deemed necessary, state agency employees could follow up later, and separated workers who are ultimately deemed ineligible could be cut off from additional benefits. At this moment, though, the burdens of inertia and bureaucratic box-checking should rest entirely on the state. To facilitate this process, states should suspend experience rating,[27] and perhaps go even further to offer small bounties to employers who identify workers that successfully claim benefits.
States should also be creative in expanding eligibility for benefits. Federal law, for instance, already allows states to grant benefits for “short time” or “work sharing” employees, those whose positions are not eliminated but whose hours are reduced.[28] Nevertheless, about twenty states do not make any use of this authority presently. The CARES Act incentivizes short-time programs by paying 100% of the state’s calendar-year 2020 benefits payments, and even states whose laws don’t currently authorize short time benefits can get a 50% federal contribution by entering a temporary agreement with the U.S. Department of Labor.[29]
Again, because federal law places no real caps on state benefit generosity, states have the flexibility to vastly expand benefits for part-time workers, to lengthen benefits duration, to make “replacement rates” (that is, the fraction of former wages paid by UI) much higher, and to offer transitional training and job-search assistance. Although the CARES Act provides a modest benefit for “gig” and other non-traditional workers,[30] states could still go much farther to provide a lifeline to these workers.
A traditional worry about many of these approaches, especially about long-duration and hassle-free benefits, is that they might tend to discourage workers from seeking new work. Recent social science shows these fears are overblown. Especially in recessions, when work is scarce, workers are extremely reluctant to turn down work opportunities.[31] There is, in other words, little “moral hazard” during recessions. States could return to their old policies when the crisis is far in our rear-view mirrors, but for now, there is little downside to dramatically increasing the ease and generosity of UI programs.
At some point after this crisis is over, the country will need to confront the poor program-design choices that made UI a shadow of what it was made for.[32] We hope to address some of these steps in a later installment. But even now, before such reform, the system has enough flexibility so that states can abandon decades of bad policy and transform UI into the crisis-stopper it was designed to be. States should take advantage of this flexibility promptly, to prevent unnecessary harm.
[1] Brian Galle, Professor at Georgetown University Law Center; David Gamage, Professor at Indiana University, Bloomington, Maurer School of Law; Erin Scharff, Arizona State University Law School; Darien Shanke, U.C. Davis Law School. (Brian Galle is the principal drafter of this essay and is thus listed first, with the remaining authors then listed in alphabetical order.)
[8] Readers interested in more detail can find somewhat longer summaries from Congressional Budget Office, Unemployment Insurance in the Wake of the Great Recession, CBO Pub. №4525 (Nov. 2012), and U.S. Department of Labor, Unemployment Compensation: Federal-State Partnership (May 2019), https://oui.doleta.gov/unemploy/pdf/partnership.pdf, and much more extensively in Brian Galle, How to Save Unemployment Insurance, 50 Ariz. St. L.J. 1009 (2019). http://arizonastatelawjournal.org/wp-content/uploads/2019/02/Galle-Pub.pdf
[9] See U.S. Dep’t of Labor, State Unemployment Insurance Benefits, https://oui.doleta.gov/unemploy/uifactsheet.asp.
[11] U.S. Department of Labor, Significant Features of State Unemployment Insurance Laws Effective January 2020, https://oui.doleta.gov/unemploy/content/sigpros/2020-2029/January2020.pdf.
[12] Three states, Alaska, New Jersey, and Pennsylvania, also collect some tax from employees. U.S. Dep’t of Labor, Federal-State Partnership, supra note 7, at 8.
[14] Patricia M. Anderson & Bruce D. Meyer, The Effects of Firm Specific Taxes and Government Mandates with an Application to the U.S. Unemployment Insurance Program, 65 J. Pub. Econ. 119 (1997).
[20] U.S. Dep’t of Labor, State Unemployment Insurance Trust Fund Solvency Report 2020, https://oui.doleta.gov/unemploy/docs/trustFundSolvReport2020.pdf; 20 CFR 606.32.
[22] See https://www.politico.com/states/florida/story/2020/04/03/its-a-sh-sandwich-republicans-rage-as-florida-becomes-a-nightmare-for-trump-1271172 (quoting Florida official describing Florida’s UI administration as a “sh*t sandwich.”); see also https://www.tampabay.com/news/health/2020/03/31/ron-desantis-was-warned-about-floridas-broken-unemployment-website-last-year-audit-shows/.
[25] CARES Act § 2104.
[27] At least 16 states have already done this. National Employment Law Project, Policy Brief: Unemployment Insurance Protections in Response to COVID-19: State Developments (March 27, 2020), https://s27147.pcdn.co/wp-content/uploads/State-Unemployment-Insurance-Developments-Response-COVID-19-v-2020-03-27.pdf.
[29] CARES Act §§ 2108, 2109.
[30] CARES Act § 2102.
[31] Kory Kroft & Matthew J. Notowidigdo, Should Unemployment Insurance Vary with the Unemployment Rate? Theory and Evidence, 83 Rev. Econ. Stud. 1092, 1093 (2016); Jesse Rothstein, Unemployment Insurance and Job Search in the Great Recession, Brookings Papers on Econ. Activity, Fall 2011, at 143,181; Johannes F. Schmieder et al., The Effects of Extended Unemployment Insurance Over the Business Cycle: Evidence from Regression Discontinuity Estimates Over 20 Years, 127 Q.J. Econ. 701, 703, 746 (2012).
[32] See Galle, supra note 8, at 1049–63 for proposals.
