California warned unemployment system headed for ruin without reform

SACRAMENTO, Calif. (CN) — The California Legislative Analyst’s Office released a report Monday detailing the urgent need to fix the state’s “broken” unemployment insurance system, which currently faces significant financial challenges incurred during the pandemic, including an outstanding $20 billion loan from the federal government.

“Unless changes are made, the state will have no reserves when the next recession begins,” a Legislative Analyst’s Office in an infographic accompanying the report said.

The main problem with the system involves its lack of self-sufficiency. Since the pandemic, unemployment benefits have routinely outpaced incoming tax contributions, even during periods of relative economic stability. This has led to a costly reliance on federal loans and has constrained the state’s options to expand benefits.

To solve the current crisis, the analyst’s office has recommended a full redesign of how the state’s unemployment insurance receives tax dollars.

“The challenges currently faced by the system are unprecedented. The system has never before had a loan from the federal government of this magnitude nor has the system run persistent deficits during a period of economic growth,” Ann Hollingshead, one of the authors of the report, said in an interview.

California’s unemployment insurance program is a state-federal partnership where workers receive partial wage replacement if they lose their jobs. To fund these benefits, employers pay a payroll tax on each worker annually, which is later put into a trust fund handled by the state.

When an eligible worker becomes unemployed, the state pays them benefits out of the trust fund. Unemployed workers can receive 50% of their regular wages up to $450 per week, for up to 26 weeks.

The Covid pandemic tested the program, which saw record numbers of citizens applying for unemployment benefits — over 18.5 million initial claims in 2020 alone. Although the state entered the crisis with $3 billion in its reserves, it was forced to borrow money from the federal government to meet its obligations.

Now, that $20 billion federal loan is coming to rear its ugly head. The loan is projected to cost the state’s general fund about $1 billion per year and the unemployment program is expected to run a deficit of $2 billion each year for the next five years.

These circumstances make expanding unemployment benefits an improbable goal for politicians. Benefits have not increased since 2004 and have not been adjusted for cost of living even through the recent periods of historically high inflation.

But recovery is not impossible, the analyst said, and laid out four recommendations to fix the system.

First, the report recommends dramatically increasing California’s taxable wage base — currently the lowest in the nation — from $7,000 to $46,800. Currently, funds for the program aren’t drawn from employees’ entire annual wages, just the first $7,000 they make.

The analyst’s office said this higher base would increase the amount of revenue the state can generate for unemployment benefits by putting it in the top 10 states ranked by taxable wage bases.

Second, the office recommended redesigning the tax structure with a standard rate base in mind. At this standard rate, the program could cover its usual costs, and when the state needs to build a cushion for itself it could levy a temporary “reserve-building rate” on top of it until saving targets are met.

Third, the office recommended a new system that bases employers’ tax rates on increases or decreases in their employment, rather than an exact accounting of their former workers’ unemployment insurance costs under the current scheme.

Finally, the office advised the state to refinance its current $20 billion federal loan to share the burden carried by businesses in the form of a revenue bond paid back by employers and new borrowing to be paid back by the General Fund.

“As long as the federal loan remains outstanding, even an improved tax system would probably not be able to build reserves ahead of the next recession,” the analyst said.

While acknowledging its recommendation would result in significant tax increases for employers, the analyst said making changes now would let the state build a simpler, more efficient system for financing its unemployment program.

The California Legislative Analyst’s Office is a government agency that has provided nonpartisan fiscal and policy advice to the Legislature since 1941.