By CalTax Policy and Communications Associate Dustin Weatherby
Prior to the COVID-19 pandemic, California had record-low unemployment of 3.5 percent in September 2019 and record reserves to weather an economic recession. The sudden economic shutdown on Friday the 13th of March 2020 led to millions of Californians waiting in unemployment call-center hotlines and a sharp tax revenue decrease for the state government.
Unemployment peaked at 16.2 percent in April and improved only moderately to 11 percent in September, 3.1 percent higher than the national unemployment rate. According to the Employment Development Department (EDD), California began 2020 with a $3.2 billion unemployment insurance fund (UI) surplus. Once the pandemic hit, the fund’s solvency lasted only six weeks – it became insolvent on April 29. The fund fluctuated in and out of solvency until it entered a deficit beginning June 3.
To pay unemployment claims, California began taking federal UI loans under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), which additionally waived federal interest payments until January 1, 2021.
To date, California has taken $15.4 billion of the $39.8 billion in federal loans issued nationally, according to the U.S. Department of the Treasury. The EDD estimates that California will end this year with a UI fund deficit of $21.5 billion. Once 2020 ends, California will begin paying 2.4 percent interest on the federal loans.
Federal loan repayments fall squarely on the shoulders of California employers unless the state repays the loans within two years. The EDD estimates that California employers will pay the maximum 6.2 percent tax rate on the first $7,000 of wages through 2021 and possibly beyond. Under normal circumstances, this tax of $434 per employee paid to the state to fund unemployment insurance is offset by a federal tax credit through the Federal Unemployment Tax Act (FUTA). However, if a state maintains a UI deficit for two calendar years, the federal credit is reduced, resulting in a surcharge on employers, used to repay the federal loans.
While this system ensures that Californians have a safety net when they lose a job, it also has the effect of raising taxes on employers during recessions, when they can least afford it.
During the 2008-09 recession, California took $10 billion in federal loans and did not repay them within two years. As a result, the federal government began reducing employers’ FUTA credit. By law, the credit reduction schedule is 0.3 percent for the first year and an additional 0.3 percent for each year thereafter, up to a maximum 5.4 percent credit reduction, until the loan is repaid in full.
California’s UI fund went into a deficit in 2009, and California companies paid an additional surcharge for seven years – from 2011 until 2018, when the loans were completely repaid. As a result, California employers paid an additional $9.6 billion in taxes. At its worst point during that period, California’s UI fund deficit hit $10.1 billion in 2012.
The situation is more dire now. The EDD estimates that California will have a $48.3 billion fund deficit for 2021 (see chart, above), nearly five times larger than the catastrophic number from 2012.
The EDD estimates that federal tax credit reductions will begin with tax year 2022 and will continue for the foreseeable future, potentially saddling businesses with additional tax burdens for decades.
California businesses already are paying their fair share to weather the COVID-19 storm. To close an estimated $54.3 billion budget deficit, the Legislature and governor passed legislation requiring businesses to pay an additional $9.2 billion in taxes over the next three years via a limit on credit utilization and suspension of the net operating loss deduction.
The Legislature proposed more than $82.8 billion in new annual taxes and fees during this year’s session alone. The proposals included a value-added tax on goods and services that would raise the cost of doing business, and even a tax on California jobs. These proposals are concerning, since our economic recovery and unemployment system rely on companies rehiring and bringing jobs back to California.
Without federal intervention, state loan repayments, and a complete revamping of the EDD’s systems, California businesses will face significant employment tax burdens, further hampering efforts to reduce unemployment and recover from the pandemic. Many small businesses – the backbone of the California economy – may never reopen. Larger businesses may choose to relocate their workforce to areas with lower operating costs. With the pandemic making remote work more popular and easier, these employers may elect to never bring those jobs back, leaving California in a precarious financial situation.
The bottom line is that California will not be able to shore up its UI fund if it simultaneously approves policies that cause more unemployment. Economic recovery and jobs are the keys to addressing UI funding problems, and should be the focus of all policy discussions.