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.
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The unemployment insurance (UI) system is a partnership between the federal government and state governments that provides a temporary weekly benefit 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 amount of wages that is 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, or both.
Under FUTA, employers pay taxes on up to $7,000 of each worker's wages; 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 UI taxes paid, for a net tax rate of 0.6 percent—or $42 per year for each employee earning at least $7,000 annually.
During and after the last recession, funds in the designated federal accounts were insufficient to pay the emergency and extended benefits authorized 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.
In 2017, SUTA revenues were $38 billion and FUTA revenues were $8 billion. CBO projects that if current law remained in place, combined SUTA and FUTA revenues would decrease to $35 billion by 2021, continuing a trend that began in 2012, before rising to $61 billion by 2028. The increase in revenues in later years reflects CBO's expectation that many states would take action to maintain historic ratios of trust fund balances to wages and salaries.
This option would expand the FUTA taxable wage base but decrease the tax rate. Specifically, the option would raise the amount of wages subject to the FUTA tax from $7,000 to $40,000 in 2019 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. 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 taxable wage base to $40,000 if this approach was adopted. (The taxable wage base varies considerably from state to state. In 2018, 16 states have a base above $20,000, but only 2—Hawaii and Washington—have taxable wage bases above $40,000.) UI benefits would not be affected.
Effects on the Budget
CBO estimates that this option would raise revenues by $18 billion from 2019 to 2028. Under the option, revenues would rise initially but fall in later years. The initial rise would primarily be attributable to added proceeds from SUTA taxes. Most states would see a substantial increase in their tax bases that, without adjustments to the tax rate, would raise more revenue. CBO expects that beginning in 2020, many states would respond by reducing their UI tax rates but would leave those rates high enough to generate a net increase in revenues over the 2019-2028 period. (States with low UI account balances would be especially likely to allow the increase in the taxable wage base to generate additional revenues without promptly lowering UI tax rates.) The extra revenues generated during the initial years would also leave the states with larger trust fund balances than CBO projects they would have otherwise. That would reduce the need for states to raise revenues to maintain historic ratios of trust fund balances to wages and salaries. As a result, in later years, estimated revenues under this option are lower than CBO projects they would be under current law.
The estimate for this option is uncertain for two key reasons. First, the estimate relies on CBO's projections of the economy, including projections of labor force characteristics and wages and salaries, over the next decade. For example, if employment is lower than expected, fewer workers will be paying the FUTA and SUTA taxes; in that case, changes in the tax rates would have a smaller impact on revenues. Second, the estimate relies on projections of how states would respond to an increase in the tax base and to changes in their UI trust fund balances.
The main advantage of this option is that it would improve the financial condition of the federal portion of the UI system. By expanding the taxable wage base, it would also improve the financial condition of state UI systems. The additional revenues resulting from this option would allow federal UI accounts to more rapidly repay the outstanding advances from the Treasury's general fund and would better position those accounts to finance benefits during future recessions. By reducing states' reliance on transfers from the general fund, this option would decrease what are effectively loans from all taxpayers (including nonworkers) to workers who benefit from having insurance against unemployment.
An argument against this option is that employers would generally pass the increased FUTA taxes on to workers in the form of reduced earnings. By reducing workers' after-tax pay, this option might induce some people to drop out of, or choose not to enter, the workforce. Moreover, for some people in the workforce, the option 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.) Because the increase in marginal tax rates would reduce the share of returns from additional work that those people could keep, CBO estimates that, on balance, it would tend to cause people to work less than they would have otherwise. However, given the small changes in after-tax pay and marginal tax rates that would result from this option, the effects on labor force participation and hours worked would probably be quite small.
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 prior earnings receive, on average, UI benefits that are a higher fraction of those earnings, the benefits are progressive. If taxes and benefits are considered together, the UI system is generally thought to be roughly proportional—neither progressive nor regressive—under current law. This option would reduce the regressivity of the FUTA tax.