Increase Taxes that Finance the Federal Share of the Unemployment Insurance System

CBO periodically issues a compendium of policy options (called Options for Reducing the Deficit) covering a broad range of issues, as well as separate reports that include options for changing federal tax and spending policies in particular areas. This option appears in one of those publications. The options are derived from many sources and reflect a range of possibilities. For each option, CBO presents an estimate of its effects on the budget but makes no recommendations. Inclusion or exclusion of any particular option does not imply an endorsement or rejection by CBO.

Billions of Dollars 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2017-2021 2017-2026
Change in Revenues                        
  Increase the net FUTA rate to 0.8 percent 1.1 1.5 1.5 1.5 1.5 1.5 1.5 1.6 1.6 1.6 7.1 14.9
  Increase the FUTA wage base to $40,000, index the base to future wage growth, and decrease the net FUTA rate to 0.167 percent 14.9 11.9 3.9 -0.1 -2.2 -2.2 -2.6 -3.5 -3.4 -3.7 28.4 13.1

This option would take effect in January 2017.

FUTA = Federal Unemployment Tax Act.

The unemployment insurance (UI) system is a partnership between the federal government and state governments that provides a temporary weekly benefit—consisting of a regular benefit and, often during economic downturns, emergency and extended benefits—to qualified workers who lose their job through no fault of their own. Funding for the state and federal portions of the UI system is drawn from payroll taxes imposed on employers under the State Unemployment Tax Act (SUTA) and the Federal Unemployment Tax Act (FUTA), respectively.

The states administer the UI system, establishing eligibility rules, setting regular benefit amounts, and paying those benefits to eligible people. State payroll taxes vary; each state sets a tax rate schedule and a maximum wage amount subject to taxation. Revenues from SUTA taxes are deposited into dedicated state accounts that are included in the federal budget.

The federal government sets broad guidelines for the UI system, pays a portion of the administrative costs that state governments incur, and makes advances to states that lack the money to pay UI benefits. In addition, during periods of high unemployment, the federal government has often funded, either fully or partially, temporary emergency benefits, supplemental benefits provided through the extended benefits program, or both.

Under FUTA, employers pay taxes on each worker’s wages up to $7,000; the revenues are deposited into several federal accounts. The amount of wages subject to the FUTA tax (the taxable wage base) is not adjusted, or indexed, to increase with inflation and has remained unchanged since 1983. The FUTA tax rate, which is 6.0 percent, is reduced by a credit of 5.4 percent for state unemployment taxes paid, for a net tax rate of 0.6 percent—or $42 for each employee earning at least $7,000 annually. On January 1, 1976, a surtax of 0.2 percent went into effect, raising the total FUTA tax rate, net of the state tax credit, to 0.8 percent—for a maximum of $56 per employee. That surtax expired on July 1, 2011.

During and after the last recession, funds in the designated federal accounts were insufficient to pay the emergency and extended benefits enacted by the Congress, to pay the higher administrative costs that states incurred because of the greater number of people receiving benefits, or to make advances to several states that did not have sufficient funds to pay regular benefits. That shortfall necessitated that advances be made from the general fund of the U.S. Treasury to the federal accounts. Some of those advances must be repaid by the states, a process that the Congressional Budget Office expects will take several more years under current law.

This option includes two alternative approaches that would increase revenues from unemployment insurance taxes by roughly the same amount over the 2017–2026 period. The first approach would leave the FUTA taxable wage base unchanged but would raise the net FUTA tax rate by reinstating and permanently extending the 0.2 percent FUTA surtax. CBO estimates that this approach would generate a steady flow of additional revenues in each year between 2017 and 2026, for a total increase of $15 billion.

The second approach would expand the FUTA taxable wage base but decrease the tax rate. Specifically, the approach would raise the amount of wages subject to the FUTA tax from $7,000 to $40,000 in 2017 (and then index that threshold to the growth in future wages). It would also reduce the net FUTA tax rate, after accounting for the 5.4 percent state tax credit, from 0.6 percent under current law to 0.167 percent. Expanding the FUTA taxable wage base would also increase SUTA taxes, which are counted as part of the federal budget. Because federal law requires that each state’s SUTA taxes be levied on a taxable wage base that is at least as large as that under FUTA, nearly all states would have to increase their tax base to $40,000 if this approach was adopted. CBO estimates that this approach would raise revenues by $13 billion over the 2017–2026 period.

Under this second alternative, revenues would rise initially but fall in later years. They would rise substantially at first primarily because of the added proceeds from SUTA taxes. However, CBO expects that, in the years after 2017, many states would respond by reducing their UI tax rates but leave those rates high enough to generate some additional revenues, on net, over the 2017–2026 period. (States with low UI account balances would be especially likely to allow the increase in the taxable wage base to generate additional revenues.) The extra revenue generated during the first years would also leave the states with larger trust fund balances. That would reduce the need for states to raise revenues to improve their trust fund balances in later years.

The main advantage of both approaches is that they would improve the financial condition of the federal portion of the UI system. By expanding the taxable wage base, the second approach would also improve the financial condition of state UI tax systems. The additional revenues resulting from either approach would allow federal UI accounts to more rapidly repay the outstanding advances from the general fund and would better position those accounts to finance benefits during future recessions. By reducing reliance on advances from the general fund, both approaches would decrease what are effectively loans from all taxpayers (including nonworkers) to workers who benefit from having insurance against unemployment.

Either approach would generally be simpler to implement—especially for employers—than many other proposed changes to the federal tax code. However, expanding the taxable wage base would impose some burden on state governments, requiring them to ensure that their tax bases conformed to the indexed federal tax base.

An argument against both approaches is that employers would generally pass on the additional FUTA taxes to workers in the form of reduced earnings. By reducing workers’ after-tax pay, the tax might induce some people to drop out of, or choose not to enter, the workforce. For some people in the workforce, both approaches would increase marginal tax rates by a small amount. (The marginal tax rate is the percentage of an additional dollar of income from labor or capital that is paid in taxes.) On balance, CBO estimates that increasing marginal tax rates reduces the amount that people work relative to what would have occurred otherwise. Given the small size of the tax changes and corresponding changes in after-tax pay that would result from either approach, the effects on employment would probably be quite small under this option.

The combination of a single tax rate and low thresholds on the amount of earnings subject to the tax makes the FUTA tax regressive—that is, FUTA taxes measured as a share of earnings decrease as earnings rise. Even so, because workers with lower earnings receive, on average, UI benefits that are a higher fraction of their prior earnings than do workers with higher earnings, those benefits are progressive. If taxes and benefits are considered together, the unemployment insurance system is generally thought to be roughly proportional—neither progressive nor regressive—under current law. Neither approach described in this option would affect UI benefits. However, the approaches would have different effects on the distribution of tax burdens: Reinstating the surtax would increase FUTA taxes proportionately for all income groups, whereas expanding the wage base and lowering the FUTA rate would reduce the regressivity of the FUTA tax.