Spring 2004

Table of Contents

Cal-Tax Home

Email Editor

Cal-Tax Commentary

Carol Evans is vice president of the California Taxpayers’ Association and a member of the California Employment Development Department’s UI Study Committee.

Returning solvency to California’s Unemployment Insurance program will require restoring balance to the system. According to the Legislature’s budget analyst, there are three options for the Legislature and Governor Arnold Schwarzenegger to rescue California’s bankrupt UI fund before things get even worse: Cut benefits, raise taxes, or both.

While that is perhaps the most direct approach, a more thorough analysis of all program elements is California’s best chance to regain a solvent program. That analysis is under way, and a complete package of proposals will soon be released by a working group of California employers. Expect to see a vast array of ideas including national standards for program eligibility, restructuring of the financing system and administrative efficiencies.

From its inception, this nation’s unemployment insurance (UI) system has been a beautifully simple and efficient program. Historically there have been only two players in the game, employers and claimants. This is in stark contrast to the workers’ compensation system, which also includes scores of providers and specialists, insurers and attorneys. Ideally, the balance in that program should also be between the needs of claimants and employers, but that has been lost in the feeding frenzy of all those making a living off the program.

Fortunately for California’s UI system, claimants and employers remain the only interested parties, which should mean solving this crisis should not be as complicated a task, but will require evaluation of all options to arrive at the most prudent solution. Because the UI program is funded 100% by employers, the primary responsibility will fall on the backs of employers. All options must be explored to restore balance and minimize the impact on employers, claimants, jobs and California’s economic recovery.

Starting in 1935, when the UI program was first created in federal law as part of the Social Security Act, it was created with a balance between federal and state responsibilities. The program is administered pursuant to state law, which prescribes each state’s tax structure, qualifying requirements, benefit levels and disqualification provisions. The states’ laws must, however, conform to federal requirements. The federal government is responsible for financing state administrative costs, funded through a federal payroll tax on employers, but states are responsible for financing benefits, which are funded through a state payroll tax on employers.

The program is intended to be balanced between two primary objectives. The major objective is to provide unemployed workers the means of getting through a temporary period of involuntary unemployment without having to turn to welfare and without having to face a needs test. The other objective serves the business community by releasing money into circulation through the payment of benefits at the outset of a local or national economic downturn, thus helping to slow down recessionary pressures.

Following are key elements for a state to maintain a successful UI program:

• A successful program must maintain a balance between appropriate eligibility standards with adequate benefits for claimants on one side, and reasonable program costs for employers on the other.

• Within the benefit schedule, a successful program must maintain an appropriate balance between a wage replacement level that is adequate, but not so generous as to create a disincentive to look for new employment.

• Within the experience-rating system which determines each employer’s tax rate, a successful program must maintain a balance between non-charged benefits (also called socialized costs or ineffective charges) vs. direct benefit charges. Otherwise, the incentive for employers to manage their charges and claims is lost.

• A successful program maintains a balance in the number of tax schedules and their triggers to avoid severe fluctuations in employer tax rates from year to year.

• A successful program maintains a balance between adequate reserves in its UI Fund to avoid insolvency during bad economic times, and over- building reserves in good times as to entice frivolous or inappropriate use of trust funds.

How are we doing? California’s UI system is obviously seriously out of balance.  The UI Fund flat ran out of money in January, necessitating a $1.4 billion loan from the federal government to continue paying benefits. And without restoring balance through major changes, California’s UI fund will continue to build deficits.

Despite repeated warnings from the business community that proposed changes would bankrupt the system, legislation was passed in 2001 mandating a 95% increase in benefits and a 30% increase in wage replacement levels. Adding insult to injury, an unprecedented and costly retroactive benefit increase was approved in 2002.

These actions paid no heed to the need for balance, and crashed the system. It’s time to get back in balance.