Editor's note: Wednesday we started our series -- in partnership with public radio's Marketplace -- about the history and limitations of the U.S.'s patchwork unemployment insurance system. Today we're looking at how state unemployment trust funds are financed -- and how that contributed to the current crisis.
It used to be, unemployment insurance meant a sturdy back and a jalopy big enough to fit the whole family. That changed in 1935, when the government started offering unemployment insurance, and states began to save when times were good so there was money to spend to help workers and stimulate the economy when times were bad.
In all but a handful of states, it no longer works that way.
Fourteen states have already run out of funds to pay unemployment insurance claims and taken out a total of more than $8 billion in federal loans to cover the shortfalls. At least 18 more states are in danger of exhausting their unemployment insurance trust funds.
States with empty unemployment insurance trust funds have pointed to the severe recession as the cause for their plight, but a closer examination of their trust funds shows underfunding and poor planning as the main culprit. Instead of building up reserves during good years, legislatures in these states yielded to political pressure for high benefits and low taxes. The result: dangerously low trust fund balances.
Now, states with bankrupt trust funds will have to increase taxes or cut unemployment benefits at the worst possible time -- during a recession.
"This is not a very smart way to run a railroad, because you want benefits to be available quite freely when unemployment rates go up, and you don't want to raise taxes on employers during a recession," said Gary Burtless, an economics expert at the Brookings Institution. "There used to be rules most states abided by, but those standards kind of went the way of the dodo bird."
Federal loans will ensure that states can keep mailing out benefit checks. But the loans pass costs along to federal taxpayers, including people who live in states where unemployment insurance is sufficiently funded. Nor will they solve the long-term unemployment insurance crisis. Taxpayers in states that have borrowed money will have to foot the bill for tens of millions of dollars in interest charges, which must be paid out of the state's general budget because rules prohibit using unemployment insurance funds.
At the end of 2007, after years of increasing employment and before the current recession hit, 33 states had less than a year's worth of reserves in their trust funds, even though many experts recommend 18 months' worth. Four states had negative balances in the years before the recession started.
By the end of 2008, 21 states had less than 6 months of reserves in their trust fund and tax revenues that were not keeping up with the money spent on benefits.
Consider Indiana, which has already borrowed more than $700 million to cover the negative balance in its trust fund account. In 2000, looking at a $1.6 billion surplus, the General Assembly lowered its tax rate and increased benefits; since then, the trust fund has been slowly bleeding.
"Even during good economic times it was still being systematically drained," said Marc Lotter, spokesman for the Indiana Department of Workforce Development. "The current economic crisis did not create the problem, it exacerbated it."
To fill the hole, Indiana recently enacted a 35 percent tax increase on businesses, but the chief financial officer of the state's unemployment insurance system said even that will not be enough to repay the federal government in time to avoid penalties.