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California unemployment debt: How to dig out of a $20 billion hole?

Masked kitchen worker wraps a slice of pizza.
Martin do Nascimento
Julia Elliott prepares slices of pizza for customers at Nabolom Bakery in Berkeley on Jan. 19, 2022

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You may have heard how phony pandemic jobless claims swamped California, or how frantic callers jammed phone lines with questions that the state’s employment agency struggled to answer.

But there’s yet another problem with the Golden State’s unemployment system that’s been brewing quietly during the pandemic: California now bears the unhappy distinction of having about as much unemployment debt as all other states combined.

When California pays out unemployment benefits, the money has to come from somewhere.

That somewhere is the state’s unemployment insurance trust fund, a pool of cash funded by a tax on employers. Millions have used unemployment benefits during the pandemic, draining existing reserves, and now the state is in debt to the tune of nearly $20 billion. Most states have no debt.

The debt will get paid off. But how soon will it get paid off, and how many taxpayer dollars will go toward that?

Under the current system, it’s going to take years of higher taxes on employers, who fund the benefits, to pay it back. Gov. Gavin Newsom proposed using $3 billion of the state’s projected $21 billion surplus to take a bite out of that debt, in addition to hundreds of millions to cover the loan’s interest payment, when he unveiled his budget proposal in January. While that proposal is intended primarily to help businesses, there’s no guarantee businesses will reap a benefit directly, especially in the short term.

California’s unemployment system was on dicey footing even before the pandemic, rated as the least financially stable system of all 50 states in February of 2020 by the U.S. Department of Labor.

The sharp economic shock of a pandemic was hard to predict. But California’s unemployment system, it now appears, is having a uniquely hard time clawing its way back to normal. If the way California funds unemployment doesn’t change, economists say, we could see the unemployment system go into debt again and again.

How did we get here?

California’s unemployment system has an important piggy bank: the unemployment insurance trust fund. Employers put money into it on a regular basis via taxes. Workers receive money from it when they get unemployment benefits.

The federal government loaned money to many states early in the pandemic to shore up their unemployment funds. But two years later, several states have paid off their federal loans, while California’s balance remains the highest of any state.

One key problem is that while California lawmakers have increased unemployment benefits over past decades, in part to keep up with inflation, the money flowing into the system from employers has not kept pace, said Audrey Guo, an economist at Santa Clara University who studies unemployment insurance.

On top of that, more Californians have been out of work throughout the pandemic compared to the national average. The national unemployment rate surged to 14.7% in April of 2020, and had come down to 8.4% by August of 2020, according to data from the Bureau of Labor Statistics.

But California’s jobless rate shot higher and didn’t fall back as quickly. It reached 15.9% in April of 2020, and was still at 11.9% by August. In December 2021, California still had one of the highest unemployment rates in the nation.

In addition, many states used federal COVID relief money to pay off some or all of their unemployment insurance debt, but California hasn’t done that.

One reason the money from employers hasn’t kept up is that California taxes employers only on the first $7,000 a worker earns each year. For example, a business that employs a part-time sanitation worker making $8,000 per year and an accountant making $100,000 per year would pay the same amount into the unemployment piggy bank for both workers each year.

But unemployment benefits cover 50% of a worker’s wages, up to a limit of $450 per week. The average weekly benefit paid out in California in 2021 was less than $320, according to federal Labor Department data. About 28% of Californians working full time earned less than $35,000 in 2019, according to Census estimates.

So, if those two workers both got laid off and started receiving unemployment benefits, the accountant would get much larger checks than the sanitation worker.

The $7,000 figure — called a taxable wage base — is “preposterous,” said Mark Duggan, an economist at Stanford who studies unemployment insurance. It’s the lowest amount allowed by federal law, only a few other states use it, and it hasn’t changed since at least 1984. Since then, the internet has become widely available, mom jeans have gone out of style and come back again, and, importantly, wages and unemployment benefits have increased.

Other states have made adjustments. Washington taxes employers on the first $56,500 a worker makes, while Oregon’s taxable wage base is $43,800. And it’s not just blue states: North Dakota and Utah both have tax bases over $38,000.

This doesn’t mean California employers are necessarily cheapskates by comparison. In fact, the taxes California employers pay as a share of total wages workers make is close to the national average: They’re paying a higher tax rate on a smaller amount of wages. But, that setup has a drawback.

If employers wind up passing the tax on to employees in the form of reduced wages, hours or fewer jobs, it’s a regressive system, Duggan points out. The lowest wage workers — especially seasonal, part-time, and student workers — end up subsidizing the cost of higher unemployment benefits for higher-wage workers. A sanitation worker with two part-time jobs that each pay $8,000 would have twice as much put into the system by her two employers compared to the accountant making $100,000 at his one, full-time job.

“Our system works terribly for the most disadvantaged workers in the economy,” said Duggan. “It works great for people who earn six-figure incomes.”

This isn’t the first time California’s unemployment piggy bank has had to turn to the federal government for loans. In the wake of the Great Recession, the fund went into about $10 billion of debt, and it took California employers roughly a decade to dig the fund out. Taxpayers wound up footing a roughly $1.4 billion dollar bill for interest payments on that loan. In fact, in 2016, when California employers were still paying down the Great Recession debt, analysts at the nonpartisan Legislative Analyst’s Office warned that the fund could go into debt again during the next recession.

So what happens next?

To start chipping away at the debt, federal law will automatically increase the federal taxes California employers pay in 2023 by 0.3%, or $21 per employee. The tax will continue to go up by an additional $21 per employee each year until the debt is repaid, which could be in the early 2030s assuming there’s not another recession before then.

Whether that’s a small or large increase depends on where you stand.

The tax increase coming for California businesses each year is so small that economists would likely have a hard time measuring its impact with statistical research methods.

It’s a small increase relative to the salaries employers are already paying their workers annually, according to a California Budget and Policy Center analysis shared with CalMatters. For companies paying workers minimum wage full time, the tax increase would amount to less than a .5% increase in annual payroll costs in 2029, after the tax has ratcheted up for several years. For companies paying workers higher than minimum wage, the proportional increase would be smaller.

But a cohort of nearly 20 business groups argued in a letter to Newsom last December that the tax increase is large enough to negatively impact hiring in the coming years.

Economic research does bear out that when the cost of employing people goes up, employment goes down, said Andrew Johnston, an economist at UC Merced who studies unemployment insurance. The usual estimate, he said, is that if you increase labor costs by 10%, companies will reduce employment by about 5%.

The tax increase coming for California businesses each year is so small that economists would likely have a hard time measuring its impact with statistical research methods, but that doesn’t mean it will have no effect, he said. Johnston has found that unemployment tax increases of as little as 1 percentage point had a measurable effect on already cash-strapped firms when it came to hiring. In other words, California companies that are already barely scraping by might be more likely to change hiring decisions in reaction to a small tax increase.

Business groups also pointed out that many other states used federal COVID relief funds to help pay off their unemployment debt. They cited California’s large budget surplus for the coming year. And they made a request: that the state chip in $10 billion dollars to help pay down the debt.

“This was not a recession that was created by the business community,” said Brooke Armour Spiegel, vice president of California Business Roundtable, a business group that signed the letter. “This was a recession that was created by state policies in response to a global pandemic.”

Employers are also paying a 15% surcharge on their state unemployment tax bill, levied by the state when the unemployment fund is in rough shape. The surcharge has been in place since 2004, according to the Legislative Analyst’s Office.

Newsom’s $3 billion proposal — if it gets approved by legislators — wouldn’t preempt a tax increase on employers or provide any relief to businesses in the short term.

A group of moderate Democrats in the Assembly proposed another sum in a February letter to the governor: $7.25 billion state dollars to bring down the debt.

Newsom proposed spending $1 billion in state funds to reduce the debt, followed by another $2 billion next year in his opening budget proposal, as well as $470 million to pay off the interest that the loan will have accrued by September.

During a state Senate budget hearing in March, Sen. María Elena Durazo, a Democrat representing Los Angeles and chair of the subcommittee, asked whether the state’s low taxable wage base contributed to California’s high debt.

If the state had increased the tax base prior to the pandemic, the state would likely have less debt now, said Chas Alamo of the Legislative Analyst’s Office.

Newsom’s $3 billion proposal — if it gets approved by legislators — wouldn’t preempt a tax increase on employers or provide any relief to businesses in the short term, according to a recent assessment by the Legislative Analyst’s Office. Instead, it would potentially shorten the number of years businesses wind up paying higher taxes.

The state Department of Finance estimates that $3 billion would shorten the duration of the loan by a year, said department spokesperson H.D. Palmer in an email. But that timeline estimate, like many estimates in the budget, can change as factors like the size of California’s workforce and unemployment rate change, Palmer said.

If the $3 billion doesn’t wind up shaving a whole year off the loan period, businesses won’t see earlier tax relief, according to Alamo.

“Employers may see no direct benefit if the payment is too small to reduce the repayment schedule by a full year,” Alamo wrote in the analyst’s office analysis.

If less than a year is shaved off, the higher taxes employers pay beyond what’s needed to pay back the loan would be put in the unemployment fund for future use.

The proposed $3 billion would also reduce the amount of interest that the state has to pay over the course of the loan’s lifetime, potentially by $550 million to $1.1 billion, according to the Legislative Analyst’s Office.

The analysis also pointed out that the debt employers are set to pay off is largely separate from the issue of potentially fraudulent unemployment claims the state paid out during the pandemic. The vast majority of suspected fraud occurred via temporary federal unemployment programs, which were paid for by the federal government and did not contribute to California’s unemployment debt.

“Employers may see no direct benefit if the payment is too small to reduce the repayment schedule by a full year.”
Chas Alamo, Analyst, California Legislative Analyst’s Office

Not all business owners share the same level of concern about the debt, or the tax increase that’s coming.

“This is not something that we hear from small business owners about at all. I mean, at all,” said Bianca Blomquist, California policy director for Small Business Majority, which advocates for small business interests.

The governor’s proposal, she said, felt like a missed opportunity to give small businesses relief targeted to their needs, like helping with commercial rent or with covering the cost of offering additional paid sick days for COVID.

It’s also $3 billion that could be spent elsewhere. Families face high prices for food and gas — and have long been struggling with high rent costs, said Alissa Anderson, a senior policy analyst at California Budget and Policy Center. “Three billion could go a long way to helping those families,” she said.

Is broader reform needed?

The way California funds unemployment benefits manages to be both the least progressive and most fiscally irresponsible in the nation, by Duggan’s estimation.

Duggan, as well as economists Guo and Johnston, have a proposed fix: Triple the amount of wages that are taxable in California. Then, policymakers could also decrease the tax rate.

This would mean employers of high-wage workers would pay more into the system, which would help offset the higher benefits their workers are paid if they get laid off. Employers of low-wage workers would pay less. Done correctly, it would restore the health of California’s unemployment piggy bank, making it less likely to go into debt during future recessions, and less likely that the state winds up using taxpayer money to make large interest payments.

The Legislative Analyst’s Office has also sketched out proposals in the past for getting the fund into better shape, including increasing the taxable wage base to $12,000 while reducing benefits.

Fixing how we fund unemployment should have bipartisan appeal, Duggan argues. Those who preach progressive values should be on board with fixing a regressive system. Those who prioritize fiscal responsibility should want to reform policy that drives California into debt.

But, then there’s how actual politics works. This issue is not “sexy,” to use Duggan’s phrase. It’s hard to explain and harder still to campaign on. And while his proposal is a tax redistribution, anyone who champions it could potentially be labeled a tax raiser.

“It’s frustrating when you study economic policy to see really idiotic policies persist,” Duggan said, “because of the nature of the political process.”

Grace covers California’s economy for CalMatters. Previously, she was an editor at the Washington Monthly. She is a graduate of Pomona College.