The state of California could find itself in a world of hurt if a future economic downturn significantly increases the number of people collecting unemployment. Thanks to multiple layers of fiscal mismanagement in the past, the Golden State is the only state in the union with a zero-solvency rating attached to its unemployment insurance (UI) fund.
Zero solvency essentially means that California has no reserve funds to pay increased unemployment claims. Not only that, an economic downturn could reduce the state’s overall tax revenues by some $60 billion over three years, putting further strain on a system that relies entirely on payroll taxes for funding.
When you get down to it, the long and short of it is that the UI system in America is a convoluted system that is ultimately funded by employees. And when employees are not working, less money is being contributed to UI while more money is being taken out. It is a losing proposition no matter how you look at it.
How Unemployment Insurance Works
Unemployment insurance in this country is a joint partnership between federal and state government. It is funded by a combination of state and federal UI payroll taxes collected in much the same way FICA is collected at the federal level. The big difference is that employers pay a larger portion of UI taxes, at least on paper.
When a person loses his or her job through termination without cause, that person is eligible to collect unemployment benefits. How much is collected depends on the person’s state of residence. Some states pay higher benefits than others, just as UI taxes are higher in some states than others.
What many people do not understand is that they are ultimately paying for their own unemployment insurance. As explained by online payroll services provider BenefitMall, many employees either do not pay a lot of attention to their weekly pay stubs or don’t understand the payroll deductions detailed on those stubs.
For example, how many people know what FUTA is? If you see that on your weekly pay stub or your annual W-2, you should be aware that FUTA is an acronym that stands for Federal Unemployment Tax Act. Any money under that heading represents money deducted from your paycheck to cover UI.
The other thing to understand is that any and all payroll taxes paid by employers represents money they can’t pay to employees by way of wages and benefits. So even the employer’s portion of unemployment insurance is ultimately borne by employees who could otherwise earn more weekly pay.
Ongoing Funding Problems
Getting back to California, the current precarious situation is a direct result of how convoluted the UI system is. Both state and federal governments collect UI taxes to fund state programs, but those programs always take a hit during economic downturns – when unemployment rises and government revenues fall.
The way to keep state UI programs solvent during such downturns only adds to the mess: states borrow money from Washington in order to continue paying benefits. State legislators must then increase their own UI payroll taxes in order to return their funds to solvency and repay the money borrowed. It is a vicious cycle.
In California, legislators are at a point where they are running out of room to tax. Every time taxes go up they lose larger numbers of businesses unwilling to continue paying. This creates an untenable position because the state is increasingly relying on a smaller number of businesses to fund UI through payroll taxes. It is a house of cards waiting to crumble.