States Bracing to Pay for High Cost of Unemployment Insurance Loans

by John Stephenson | January 11, 2011

During the Great Recession, the states have relied on $41 billion in loans from the federal government to help cover the cost of unemployment insurance, which has risen due to greater and longer demands for jobless benefits. But now the bill is due. Starting this year, the states will have to make $1.4 billion in interest payments on those loans. This could mean higher taxes on the struggling business community or further strains on already broken state budgets, but it also presents an opportunity for reform.

The U.S. Department of Labor maintains a fund called the Federal Unemployment Account, which provides money for states to ensure that they can maintain unemployment insurance when demand is highest. According to the National Conference of State Legislatures, 30 states and the U.S. Virgin Islands currently borrow from this account.  The loans can be substantial; California has borrowed $8.8 billion so far. Only four of the states to take out loans from the account, namely Maryland, New Hampshire, South Dakota, and Tennessee, have repaid their loans in full. To help pay back the loans, many states have increased unemployment insurance taxes; 24 states raised these taxes last year and more will likely do so in 2011.

On December 31, 2010, a provision of the American Reinvestment and Recovery Act of 2009 expired, which means that the states currently borrowing from the account will have to begin making payments to cover the $1.4 billion owed in interest on the loans. However, states cannot use the unemployment tax revenues to make interest payments. Some states use special "solvency taxes" to raise money to pay the interest, but other states may have to issue bonds or use their general funds. In 2011, Michigan businesses will have to fork over an additional $67 in solvency taxes on top of the $477 in unemployment taxes they already pay. Last week, Texas sold $2 billion in bonds with an effective interest rate of 2.39%, which will be paid by employers. 

Raising taxes on employers should concern state policymakers because with more money going to the government businesses will have less money to spend on hiring workers. Also, states already face budget deficits totaling $26.7 billion midyear through 2011, which means that the states do not have much flexibility to diverting funds to make interest payments.

As the states grapple with finding the money to make these interest payments and maintain their unemployment insurance programs, they should take this opportunity to also look at reforms that will make the unemployment insurance system more sound and solvent. One interesting idea being floated by Oregon's Cascade Policy Institute is to create an Individual Asset Account to improve the unemployment safety net and help build up personal assets for difficult times. New ideas for unemployment insurance need to be on the table unless the states wish to continue borrowing from the federal government only to make hefty interest payments when they can least afford to do so.