California Struggles to Pay $20 Billion Debt from Unemployment Checks During COVID

You may have heard about California’s epidemic of bogus unemployment claims or how desperate callers clogged phone lines with inquiries that the state’s employment office struggled to address.

However, another issue with the Golden State’s unemployment system has been simmering silently during the pandemic: California now has almost the same unemployment debt as the rest of the states combined.

When California provides unemployment compensation, funds must be raised someplace.

That place is the state’s unemployment insurance trust fund, a collection of funds financed by an employer levy. During the epidemic, millions of people utilized jobless benefits, depleting existing reserves, and the state is now over $20 billion in debt. The majority of states are debt-free.

Debt will be repaid. However, how quickly will it be paid off, and how much public money will be spent on it?

Under the existing system, it will take years of increased taxes on employers, who pay for the benefits, to recoup the cost.

When Gov. Gavin Newsom announced his budget plan in January, he recommended spending $3 billion of the state’s estimated $21 billion surpluses to pay down that debt, in addition to hundreds of millions to meet the loan’s interest payment.

While that idea is largely aimed at enterprises, there is no certainty that firms would immediately profit, particularly in the short run.

California’s unemployment system was already precarious before the pandemic, having designated the US Department of Labor as the least financially secure 50 states in February 2020.

A pandemic’s strong economic effect was difficult to forecast. However, it now looks that California’s unemployment system is having an especially difficult time returning to normalcy. If the way California funds unemployment does not change, analysts warn, the state’s unemployment system will continue to default on its obligations.

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How Did the Debt Get That Big?

The unemployment system in California has a sizable piggy bank: the unemployment insurance trust fund. Employers contribute to it regularly through payroll taxes. When workers obtain unemployment benefits, they receive money from them.

Early in the epidemic, the federal government lent money to several states to help them shore up their unemployment reserves. However, other states have repaid their federal loans two years later, while California remains the biggest outstanding.

One significant issue is that, while California lawmakers have increased unemployment benefits in recent decades to keep pace with inflation, employers’ money flowing into the system has not kept pace, according to Audrey Guo, an economist at Santa Clara University who studies unemployment insurance.

More Californians have been unemployed throughout the epidemic than the national average. According to Bureau of Labor Statistics statistics, the national unemployment rate increased to 14.7 percent in April 2020 and decreased to 8.4 percent by August 2020.

However, California’s unemployment rate increased and did not recover as rapidly. It peaked at 15.9% in April 2020 and remained at 11.9 percent in August. California had one of the nation’s highest jobless rates in December 2021.

Additionally, while many states have utilized federal COVID relief funds to pay down part or all of their unemployment insurance debt, California has not.

Employers’ contributions have not kept pace because California taxes businesses on the first $7,000 a person earn every year.

For instance, a firm that employs a part-time sanitation worker earning $8,000 per year and an accountant earning $100,000 per year would contribute the same amount to the jobless piggy bank each year for both workers.

However, unemployment benefits cover 50% of a worker’s salary, up to a weekly maximum of $450.

According to federal Labor Department data, the average weekly benefit awarded in California in 2021 was less than $320. According to Census estimates, around 28% of Californians working full time earned less than $35,000 in 2019.

Therefore, if both individuals were laid off and began collecting unemployment benefits, the accountant would receive far bigger checks than the sanitation worker.

The $7,000 number — referred to as a taxable salary base — is “ludicrous,” according to Mark Duggan, a Stanford economist who studies unemployment insurance.

It is the smallest quantity permitted by federal law, used by just a few other states, and has remained unchanged since 1984. Since then, the internet has expanded in popularity, mom jeans have come and gone, and, most crucially, earnings and unemployment benefits have grown.

Other states have amended their statutes. Companies in Washington are taxed on the first $56,500 a worker earns, whereas employers in Oregon are taxed on the first $43,800. Blue states are affected: North Dakota and Utah have tax bases over $38,000.

It is not to say that California employers are inherently thrifty in contrast. Indeed, California firms pay close to the national average in terms of taxes as a percentage of total earnings earned by employees: they pay a higher tax rate on a lesser quantity of compensation. However, this configuration has a disadvantage.

If firms pass the tax on employees through lower salaries, hours, or job losses, Duggan notes that the system is regressive. Low-wage employees — particularly seasonal, part-time, and student workers — wind up footing the bill for higher-wage workers’ unemployment benefits.

A sanitation worker with two part-time jobs at $8,000 each would contribute twice as much to the system as the accountant earning $100,000 at his single full-time job.

“Our system fails miserably when it comes to the most disadvantaged employees in the economy,” Duggan stated. “It works well for folks with six-figure salaries.”

This is not the first time California’s unemployment fund has had to seek assistance from the federal government. Following the Great Recession, the fund incurred over $10 billion in debt, and it took almost a decade for California firms to recover.

Taxpayers ended up paying the cost of almost $1.4 billion in interest payments on the loan. Indeed, in 2016, as California firms continued to repay debt from the Great Recession, experts at the independent Legislative Analyst’s Office cautioned that the fund would default again during the next recession.

What Happens After That?

To begin paying down the debt, federal law will automatically boost federal taxes paid by California companies by 0.3 percent, or $21 per employee, in 2023.

The tax will continue to increase by $21 per employee every year until the debt is repaid, which might occur in the early 2030s, providing there is no severe recession before then.

According to a study provided with CalMatters by the California Budget and Policy Center, it’s a negligible increase compared to the annual salary firms now pay their employees.

For businesses that employ full-time minimum-wage workers, the tax increase would equal less than a.5% increase in annual payroll expenditures in 2029, after the tax had been gradually increased for several years—companies who pay their employees more than the minimum wage would see a lesser proportionate rise.

However, a coalition of almost 20 business organizations claimed in a December letter to Newsom that the tax hike is significant enough to impact hiring in future years negatively.

Economic research does support the assertion that when the cost of hiring people increases, employment declines, according to Andrew Johnston, an economist at UC Merced who studies unemployment insurance.

According to him, the conventional wisdom is that increasing labor expenses by 10% results in a 5% reduction in employment.

Each year, California firms will face a tax rise so minor that economists would likely struggle to quantify its effects using statistical research methods, but that does not imply it will have no effect, he added.

Johnston discovered that increases in the unemployment tax of as low as one percentage point had a discernible influence on hiring already cash-strapped enterprises.

In other words, California businesses that are already struggling to make ends meet may be more receptive to changing employment decisions in response to a slight tax rise.

Additionally, business organizations noted that several other states used federal COVID relief payments to repay their jobless obligation. They referenced California’s impending big budget surplus. And they made a request: that the state contributes $10 billion toward debt repayment.

“This was not a recession initiated by the business community,” Brooke Armour Spiegel, vice president of the California Business Roundtable, a business organization that signed the letter, explained. “This was a recession precipitated by governmental initiatives in reaction to a pandemic on a worldwide scale.”

Is There a Need for Broader Reform?

According to Duggan, California’s approach to unemployment compensation is both the least progressive and economically unwise in the country.

Together with economists Guo and Johnston, Duggan has offered a fix: California should triple the number of taxable salaries. Then, officials should consider lowering the tax rate as well.

This would imply that employers of high-wage workers would contribute more to the system, so offsetting the larger benefits granted to their employees in the event of a layoff.

Employers of low-paid workers would get a salary reduction. If done properly, it would rehabilitate California’s jobless piggy bank, making it less likely to default on debt during future recessions and reducing the likelihood that the state would have to use public money to make significant interest payments.