LEXINGTON, Ky. — “Reform” is a tricky word. We assume it means change we want. But we don’t always want what’s best for ourselves. Many of my business clients won’t want to hear this, but we should raise the Unemployment Insurance tax now. Hear me out; I think you’ll be on board by the end.
Kentucky’s Unemployment Insurance program allows workers who lose their job “for no fault of their own” to receive a minimal weekly stipend for a limited time to support themselves while they look for a new job. It’s not a perfect system, but it actually works pretty well for a program that has to balance the interests of workers, employers and the economy as a whole.
When a downturn generates a critical mass of unemployed workers, it creates secondary economic damage: mass foreclosures, repossessions, evictions, and the loss of consumer spending. These ripple through the economy and lead to more unemployment, and then more damage – each compounding the other in a downward spiral. The Unemployment Insurance program dampens the cycle by breaking the link between joblessness and a collapse of consumer spending. The program is help for people going through a hard time to be sure, but the purpose of the program has always been at least as much about the macroeconomic impact of mass unemployment, as it is the individual worker. It’s a shrewd investment in guarding against another depression for all of us.
While the federal government pays for most of the administrative cost of Kentucky’s program, the pool of funds that workers’ benefits are drawn from, the Trust Fund, is financed by a quarterly payroll tax (or “contribution”) employers pay on their employees’ wages. It may be termed a “contribution” due to the program’s populist, post-Depression roots, but a tax by any other name still costs the same.
The UI tax rate Kentucky employers pay is not static. The rate for individual businesses fluctuates due to several factors, including the employer’s “reserve account ratio” (an accounting mechanism to track how much each employer pays into the program versus how much their employees have drawn out in benefits, relative to their total taxable payroll), and the current balance of the Trust Fund (how much all Kentucky employers have paid in versus the total paid out in claims), which is inversely related to the unemployment rate. There’s a table in the relevant statute, KRS 341.270, that calculates your business’s tax rate based upon its reserve account ratio and the current balance of the Trust Fund.
Here’s where things get dicey: as the unemployment rate goes up, more workers draw benefits from the Trust Fund, and the Trust Fund balance goes down. This triggers a shift in the tax table, increasing the tax on all employers, regardless of their business’s reserve account ratio. At first blush, this makes sense – as the Trust Fund balance goes down, it will need more money to keep it from going negative – but this is precisely the wrong environment in which to be raising business’s tax rates.
The unemployment rate has an inverse relationship to the economic cycle; as the economy expands, employers hire more workers and the unemployment rate goes down. And, as the economy contracts, employers shed workers and the unemployment rate goes up. Under Kentucky’s UI tax scheme, businesses see their UI taxes increase as the economy contracts and the unemployment rate goes up. This placeless an added burden on businesses at the worst time, which can lead to further layoffs, compounding problems. Conversely, as the economy expands and the unemployment rate decreases, businesses get a break in their UI tax when they need it least. The UI tax acts as an amplitude amplifier, making peaks higher and troughs lower. What we want is more stability.
Kentucky businesses would be better served by a UI tax rate that shared an inverse relationship to the unemployment rate. As the economy drops, employers would get a small tax break, and as the economy ascends, employers would top off the Trust Fund in advance of the next downturn. Much like the Fed’s use of interest rates as an oscillation dampener, the state’s UI tax rate could function as a subtle airbrake when the economy is going too fast and a tailwind during economic downturns.
The Unemployment Insurance system was originally intended to be forward-funded in this way, but many states, including Kentucky, eventually drifted to a pay-as-you-go approach, where Trust Funds do not grow enough during good times to be prepared for the increased unemployment that follows periods of expansion. As a result, our UI program was not healthy enough to survive our most recent recession on its own. In 2009, after the unemployment rate rose to over 10 percent, Kentucky’s Trust Fund went bust; the program became insolvent and had to borrow close to a billion dollars from the federal government to continue paying UI benefits. That billion dollars had to be repaid with interest, by Kentucky employers through the loss of federal tax credits, the addition of a UI tax surcharge, and an increase to the taxable wage base. We should learn from that mistake so we can avoid repeating it.
Policy experts would have to make the precise calculations, but a new bill amending the tax table could reverse the current UI tax curve. The total amount employers pay would not change within any given economic cycle; the bill would just change when businesses pay throughout that cycle, paying more when they are best able, and paying less when they have less. Over time, such reform could actually lessen employers’ overall UI contributions, as employers will be better able to retain workers through downturns, which would further stabilize the labor market, thus lowering overall unemployment and boosting the size of the Trust Fund. There are plenty of other reforms that should be made, but this is low-hanging fruit most policy experts agree with. For it to work, employers would have to start saving now, when the economy is good, to have enough built up to let them coast to a softer bottom during the next recession.
James Maxson, an unemployment-insurance practice lawyer with Maxson Firm PLLC in Lexington, is a former policy adviser and in-house counsel for Unemployment Insurance in the Kentucky Office of Employment and Training, and Special Assistant Attorney General for UI crimes.