Unemployment Insurance: How It Works

Brian Galle
Aug 25, 2017 · 6 min read

This is Part 2 of a serial posting of my law review article, “How to Save Unemployment Insurance.” Part One is here. You can download the whole manuscript here.

In essence, UI is a government program jointly funded and administered by states and the federal government.[2] The federal government sets certain basic ground rules, and states can fill in most of the details.[3] States also determine whether workers and their employers have complied with state and federal rules.[4]

UI provides a partial replacement of wages for some recently-unemployed workers.[5] A worker who is fired, or is forced by certain compelling circumstances to leave, can claim benefits, while workers who quit voluntarily usually cannot.[6] In many states part-time workers are effectively ineligible for UI.[7] Eligible workers must submit a claim to a local unemployment office, and in most cases must show the office that they are available for and seeking a replacement job.[8] If a worker is found eligible, she is paid a fraction of her old wages, up to a (usually fairly low) statutory dollar-value cap; nationally, average benefits now hover around $300 per week.[9] Workers can only claim benefits for a limited period, 26 weeks in most states, although states also must provide “extended benefits” for an additional period when economic conditions worsen significantly.[10] This period has sometimes been extended further by Congress during recessions.[11]

Both state and federal governments impose taxes to pay for UI benefits and administrative costs.[12] In both cases, unemployment insurance taxes are nominally imposed on employers, but economists believe that in the long run employers are able to pass the cost of these taxes on to workers in the form of lower salaries.[13] The federal government collects state and federal taxes and holds each state’s proceeds in a Trust Fund account.[14] By federal law, employers are experience rated, so that employers whose workers file more successful claims pay a higher rate of tax.[15] Firms with very high experience-rated tax rates relative to their industry are less likely to be able to pass through these taxes to workers, which means that experience rating creates real incentives for firms to reduce turnover. [16]

The source of funding for benefits varies depending on the length of separation.[17] States pay the entirety of the costs of short-term unemployment insurance benefits from their Trust Fund accounts.[18] States and the federal government share the costs of medium-term benefits, and the special “emergency” benefits enacted by Congress during the Great Recession (and other similar temporary long-term benefits provided in the past) have historically been borne entirely by the national government.[19] The federal tax, or “FUTA,” is also used for two other main purposes: to aid states in the costs of claims administration, and to help shore up struggling state balances.[20]

The per-employee burden of federal and state taxes depends on a combination of each government’s tax rate and “taxable wage base.”[21] The base is a defined as a fixed amount of each employee’s salary.[22] For example, the federal UI tax base is $7,000; each employer pays the applicable federal rate (which can increase if the state is not in compliance with all federal requirements) on the first $7,000 earned by each employee.[23] State wage bases vary but by federal law must at least equal the federal base.[24]

Next: Why Does UI Matter?

[1] GAO, supra note 12, at 17. States that fail to adhere to the statutory financing structure subject their in-state employers to a very large federal penalty tax. No state has ever triggered this tax.

[2] U.S. Department of Labor, supra note 2, at 9.

[3] See U.S. Department of Labor, Office of Unemployment Insurance, Significant Provisions of State Unemployment Insurance Laws Effective January 2017, at 2–4 to 2–5, available at https://workforcesecurity.doleta.gov/unemploy/content/sigpros/2010-2019/January2017.pdf.

[4] Id.

[5] Stone & Chen, supra note 84, at 8.

[6] ACUC, supra note 6, at 10.

[7] [ ]

[8] Wayne Vroman, Unemployment Insurance and the Great Recession, Urban Institute Unemployment and Recovery Project Brief #2, at 4 (Dec. 2011).

[9] U.S. Department of Labor, supra note 119, at 2–17 to 2–19; Wayne Vroman & Stephen A. Woodbury, Financing Unemployment Insurance, 67 Nat’l Tax J. 253, 256–57 (2014); see Testimony of Douglas J. Holmes Before the Subcommittee on Human Resources, Committee on Ways and Means, U.S. House of Representatives (Feb. 10, 2011) (claiming that average state UI taxes rose by 34% during 2009 and 2010).

[10] National Employment Law Center, Unemployment Insurance Financing in Crisis: How Should States Respond to Trust Fund Insolvency?, Unemployment Insurance Briefing Paper, May 2010, at 3.

[11] GAO, supra note 12, at 12.

[12] Id. at 11.

[13] GAO, supra note 12, at 12 & n.26. Congress suspended these provisions for 2009 and 2010. ARRA § [??].

States are eligible for interest-free borrowing if they hit three incentive targets. First, the state must have, within five years of the borrowing date, held enough in their trust fund to pay eighty percent of the expected recession-period cost of benefits. Second, for each year since the trust-fund target was last met, the average tax rate on state employers must have been at least 75% of the average cost of benefits over the prior 5-year period. And, lastly, the average tax rate for each year of that period can have been no lower than 80% of the prior year’s tax rate. Many states have not been close to these incentives for many years. E.g., U.S. Department of Labor, Office of Unemployment Insurance, Division of Fiscal and Actuarial Services, State Unemployment Insurance Trust Fund Solvency Report 2017 60 (Mar. 2017).

[14] California may be an exception. Id. at 61.

[15] U.S. Department of Labor, supra note 2, at 8–9.

[1] For example, the UI system paid out more than $150 billion in benefits during 2010, far more than any other non-health federal program. CBO, supra note 7, at 5.

[2] GAO, supra note 12, at 4.

[3] Id. For an overview of differences in state program detail, see Nicholson & Needels, supra note 6, at 49–53. For a summary of the minimum rules imposed by federal law, see U.S. Department of Labor, supra note 2, at 3–4.

[4] U.S. Department of Labor, supra note 2, at 1–2.

[5] CBO, supra note 7, at 5.

[6] Id.

[7] National Employment Law Project, Part-Time Workers and Unemployment Insurance, at 3 (Sept. 5, 2008), available at http://www.nelp.org/content/uploads/2015/03/parttimeui0304.pdf.

[8] Christopher J. O’Leary, State UI Job Search Rules and Reemployment Services, 129 Monthly Labor Review 27, 27 (2006). Most claims can now be submitted remotely, rather than in person. Id. at 28.

[9] CBO, supra note 7, at 6.

[10] GAO, supra note 12, at 4. Commentators believe that the triggering mechanisms for extended benefits do not do a good job matching EB periods to read periods of economic hardship. ACUC, supra note 6, at 3–4.

[11] CBO, supra note 7, at 5.

[12] CBO, supra note 7, at 5.

[13] Id. at 13. Three states also collect a small fraction of UI taxes directly from employees. U.S. Department of Labor, supra note 2, at 9. For discussion of some of the empirical uncertainties of the incidence of the UI tax, see Lester, supra note 6, at 382–84.

[14] CBO, supra note 7, at 5.

[15] U.S. Department of Labor, supra note 2, at 10. Experience rating is only partial in most states, resulting in higher unemployment. Nicholson & Needels, supra note 6, at 56–57.

[16] 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).

[17] CBO, supra note 7, at 6–7. Various tax planning techniques have developed to help firms avoid experience rating, however. Charles C. Kearns, State Implementation of the SUTA Dumping Prevention Act of 2004, 11 St. & Local Tax Lawyer 105, 111–15 (2006).

[18] CBO, supra note 7, at 6–7.

[19] GAO, supra note 12, at 6–7.

[20] CBO, supra note 7, at 5.

[21] GAO, supra note 12, at 11.

[22] Id.

[23] Id.

[24] Id.

Whatever Source Derived

Thoughts on tax and the law

)