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.

According to the Executive Summary the “State’s Unemployment Insurance (UI) Financing System Is Broken. The state’s UI program is supposed to be self-sufficient-that is, the system should collect enough funds to pay for benefits over time. This means, in some years, the system will collect more than necessary so that, during most economic downturns, there is enough money to pay for rising benefit costs. That system is broken: tax collections routinely fall short of covering benefit costs. (The state’s fiscal problems are unrelated to the widespread fraud that affected temporary federal UI programs during the pandemic.) Both our office and the administration expect these annual shortfalls to continue for the foreseeable future. Under our projections, deficits would average around $2 billion per year for the next five years. This outlook is unprecedented: although the state has, in the past, failed to build robust reserves during periods of economic growth, it has never before run persistent deficits during one of these periods.”

The state’s UI tax system requires a full redesign so that contributions: (1) cover benefit costs in most years and (2) build up a reserve that can be drawn down during recessions. The Report recommend four main areas of change:

– – We recommend the Legislature increase the taxable wage base from $7,000 to $46,800, tying the taxable wage base to the amount of UI benefits a worker can actually receive ($450 per week). Taxing this level of earnings means no taxes would be paid on wages that are not covered by UI. This taxable wage base level would place California among the ten states with taxable wages bases above $40,000 and all other Western states. While necessary, this step alone would not be sufficient to address the state’s solvency problems.
– – Following federal guidelines, we recommend the state adopt a simple, robust UI tax structure comprised of a standard tax rate and a reserve-building tax rate. The standard tax rate would cover typical UI benefit costs. The reserve-building rate would help the state build up a robust reserve that can be drawn down during recessions. Under current conditions, the standard tax rate would be 1.4 percent and the reserve-building rate would be 0.5 percent, for a total of 1.9 percent UI tax rate applied to our proposed $46,800 taxable wage base.
– – We recommend the Legislature transition to a new experience rating system that bases employers’ tax rates on increases or decreases in their employment, rather than an exact accounting of their former workers’ UI costs (as the current system operates). This approach would continue to reflect, indirectly, employers’ costs to the UI system because business that reduce employment tend to have higher UI usage. Thus, this alternative approach maintains the policy goals of experience rating but does not suffer from the main downsides of the current system.
– – The outstanding federal loan complicates the state’s efforts to fix its broken UI financing system: 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. To address this, and in acknowledgment of the unique nature of the pandemic that caused the significant UI loan, we outline a shared approach to refinancing the federal loan. This would involve two equal parts: (1) a revenue bond paid back by employers and (2) new borrowing from the Pooled Money Investment Account paid back by the General Fund.

The Executive Summary concludes by saying “The scope and magnitude of our recommendations reflect the deep problems in the existing UI system. These include: (1) the staggeringly large and growing loan from the federal government and (2) the fact that the system is currently running a deficit even during an economic expansion. These are significant problems in isolation, let alone in combination. The significant changes proposed in this report are an honest reflection of these problems. However, whether or not the Legislature takes action, employers will soon pay more in UI taxes than they do today due to escalating charges under federal law. Making changes now will allow the Legislature to make strategic choices about how to repay the federal loan, while also replacing the UI financing system with one that is simpler, balanced, and flexible.”

Massive Increases in Payroll Taxes Needed to Fix “Broken” UI System