Every January, John Weithas gets a report from the payroll managers for his Pasadena Italian food market that makes him wince. It's the annual bill for his federal unemployment insurance tax.
This year the bill approached $6,000. That's a big hit for Weithas' Porta Via Italian Foods, which employs an average of about 22 workers throughout the year to prepare ready-to-eat meals for walk-in customers and catering clients. What's especially irritating from Weithas' point of view is that it's a federal assessment almost uniquely paid by California businesses.
That's because California mismanaged its unemployment insurance program worse than most other states and has been slow in rectifying the shortfall. When the last recession hit in 2008, the state fund quickly ran out of money, forcing it to borrow heavily from the federal government and running up a balance that won't be paid off until late this year. Employers have shouldered most of that cost, but taxpayers have had to chip in, too.
"This is an ugly secret that most small businesses aren't even aware of," Weithas told me recently. A Wall Street trader before coming west to open his business, Weithas may be one of the few employers who have tried to get the facts about the annual assessment. The effort has left him irritated at the state's inability to deal with a debt that has been hanging over employers for nearly a decade. "You wonder, when are we going to deal with it?"
Weithas isn't alone in sensing that something is deeply wrong with California's unemployment insurance program. Employers see the cost as yet another factor in what makes the state a difficult place to do business. Employee advocates, on the other hand, observe that the state's benefits are modest compared with many other states.
More problems will arrive along with the next recession. The state's unemployment insurance reserve is expected to reach about $1.8 billion by the end of 2018 after several years in the red, but will almost certainly go back in the red during the next downturn. That will require more borrowing. The federal government recommends that a state's reserve be high enough to cover a year of benefits, but California's nest egg will be only about one-third of that level at year-end.
"Everyone in California agrees that because of our tax structure, there's no way we'll have enough reserves built up" ahead of the next turn in the economic cycle, says Maurice Emsellem, program director in California for the National Employment Law Project.
The lessons of the last downturn have gone unheard in Sacramento, where pressure to fix the program today, during an economic boom and with the unemployment rate at a periodic low, is almost nonexistent.
"Now is not the time to put a proposal on the table to increase taxes and increase benefits," says Allan Zaremberg, CEO of the California Chamber of Commerce.
California is not the only state facing trouble. "Most states (especially large ones) appear to be pulling back from a commitment to UI [unemployment insurance]," Wayne Vroman of the Urban Institute and Stephen A. Woodbury of Michigan State wrote in 2014, pointing to a long-term decline in unemployment tax rates. Reserves as a share of total wages peaked in the 1960s at about 3.5%, but had fallen to about 0.79% just before the recession. Taxes as a percentage of total wages followed the same general trajectory.
But no state's unemployment fund fell into quite the hole of California's. It's the only state still paying off money borrowed from the federal government to cover benefits during the recession — which has prevented it from rebuilding a reserve.
It may be hard to focus policymakers' minds on the next recession while business seems to be so flush, but the importance of unemployment insurance as a relief valve in bad economic times can't be overstated. It's the quintessential counter-cyclical program, for benefits rise as recession deepens and ebb as recovery puts more people back to work. That keeps consumer spending from totally cratering during the downturn.
Creating a federal unemployment system was initially the main goal of Social Security's architects during the New Deal — retirement benefits became their main concern only after a grass-roots movement placed pensions on the political front burner.
Unemployment insurance was then enacted as a shared state-federal system. States are currently responsible for funding benefits up to 26 weeks out of employer assessments; the federal government covers administrative costs and benefits in excess of 26 weeks, when they're decreed by Congress.
The last benefit increase in California was enacted in 2001, to address a post-9/11 economic slump. The measure raised weekly benefits from $230 over four years, bringing the maximum weekly payout to $450 in 2005.
But it hasn't increased at all in the last 13 years. As a result, California has fallen well behind states across the nation. The state's maximum benefit currently ranks 26th nationwide. The average replacement level today of a worker's prior earnings is only 26.6%, well below the state's 50% target.
The Chamber argues that those figures are counterbalanced by California's loose eligibility rules for benefits. Employment advocates, however, dispute that the rules make much of a difference. When benefits are viewed as a percentage of the average wage, Emsellem says, California's figure ranks near the bottom — 46th in the nation. And that's for the maximum; the average unemployment benefit last year was about $325 a week, below the national average of $346 and 29th in the country, according to the National Employment Law Project. It's even skimpier if one factors in California's high cost of living.
On the other side of the ledger, California's employer tax also is among the lowest in the country. The wage base on which the state tax is assessed, $7,000 per employee, is the smallest permitted by the federal government and is matched only by Arizona and Florida, according to the Department of Labor; the national average is nearly $18,000. The smaller the wage base, the more the burden of the program falls on employers with low or moderate average wages.
The 2008 crash drained the state's unemployment insurance reserves by 2009, forcing it to borrow from the feds to pay benefits. The debt eventually reached almost $11 billion.
That raised costs for employers, who pay a federal tax in addition to the state tax. For business in most states, however, most of the federal levy is eliminated by a credit — but not in states with outstanding loan balances. The loss of the credit cost businesses in California an estimated $9.5 billion through 2017, according to the Employment Development Department, which manages the state unemployment program. Taxpayers generally get socked with the interest charges on those loans, totaling $1.43 billion.
So that's $11 billion in wasted spending that could have been applied to other needs over the last decade, all because the legislature failed to match unemployment taxes to benefits.
Even though the unemployment fund is expected to return to the black late this year, that's no cause for complacency. The Legislative Analyst's Office and EDD agree that the fund may be unable to "withstand an economic downturn" any time soon, even if its balance meets projections of $2.3 billion in 2019. In this bullish economic year, tax receipts are expected to reach $5.9 billion and benefit payments will be an estimated $5.5 billion to 885,000 unemployed workers. In a recession, however, receipts will fall sharply and benefit payments will soar.
But complacency rules. The Chamber's Zaremberg observes that in California, a tax increase requires a two-thirds vote of the legislature but a benefit increase only a majority vote. If the Legislature were to enact an unemployment tax increase to restore the surplus, he warns, "Someone will come up with a bill saying, we have a surplus, let's increase benefits."
The right approach, he says, is to "build up a surplus on the existing tax rate, and then look at a comprehensive solution."
But that's a recipe for doing nothing until it's too late. A recession will be upon us at some point, and we're unprepared. Acting now by increasing the rate base and benefits will ensure that the state is forearmed against the coming challenge. That will make the unemployment system more useful in the short run, and cheaper in the long run.