The University of Chicago

School of Social Service Administration Magazine

Volume 21 | Issue 1 | Winter 2014
Not Working How unemployment insurance is funded affects where it works and where it’s stumbling

Efforts to undo the social welfare programs of the New Deal and the Great Society have had mixed results. While talk of changing Social Security remains mostly talk, for example, food stamps have come under heavy attack.

The traditional view holds that social insurance programs financed by dedicated taxes, like Social Security, are more durable than programs financed by legislative appropriations, like food stamps or welfare. And yet one important New Deal program financed by payroll taxes—unemployment insurance—has diminished over time, with benefits shrinking and insolvency threatening the program in many states.

In an article in the September 2013 Social Service Review, Alexander Hertel-Fernandez, a Ph.D. student in the department of government and social policy at Harvard, burrows into the political and fiscal history of unemployment insurance from 1978 to 2008. He concludes that the program’s troubles began at birth, with a funding mechanism that left it vulnerable to retrenchment.

Unemployment insurance began as part of the Social Security Act of 1935. Its aim was both to provide relief for jobless workers and to stabilize the economy. Indeed, in 2010, unemployment insurance kept 4.6 million workers out of poverty, according to the Center on Budget and Policy Priorities.

But while Social Security was a national program from the start, unemployment insurance was left largely to the states. Here’s how it works: A federal payroll tax pays for administrative costs and provides extended benefits during periods of high unemployment. But regular benefits to jobless workers are paid out of state funds, primarily from taxes that employers pay on employees’ wages. The level of benefits, the rate of taxation and, most critically, the maximum amount of an employee’s wages subject to the tax—called the taxable wage base—are all determined by the states.

This funding system meant benefits came to vary from state to state, as did the overall financial health of the programs. A key factor has been whether or not states index their unemployment taxes to inflation by allowing the taxable wage base to increase over time. In the states that don’t index, the state government may periodically pass legislation to increase the taxable wage base. But where conservatives have dominated, resistance to these adjustments has kept unemployment funds low and benefits meager.

Periods of high unemployment push the unemployment programs in many states to the brink of insolvency, forcing the state to borrow from the federal government. Critics often blame these crises on overly generous benefits. But Hertel-Fernandez says his research shows that variations in funding have mattered more. In 2011, for example, 65 percent of non-indexing states owed the federal government money at the end of the year, while only 25 percent of indexing states did.

Both unemployment insurance and Social Security had the same taxable wage base when Congress established them in the 1930s, but they have long since diverged. The federal part of the unemployment insurance tax, which sets a minimum standard for the states, is today based on a taxable wage base of $7,000, compared to more than $100,000 for Social Security.

Hertel-Fernandez points out that the federal government could increase or even index the taxable wage base for its part of unemployment insurance, which would force states to raise or index theirs. Alternatively, the feds could offer incentives to states to improve the solvency of their insurance funds. Neither solution, he concedes, is likely in today’s political climate.

Hertel-Fernandez, Alexander. “Dismantling Policy through Fiscal Constriction: Examining the Erosion in State Unemployment Insurance Finances.” Social Service Review 87 (3): 438 – 476.