What Is Unemployment Insurance?
The Unemployment Insurance (UI) system is a joint federal-state program with two main purposes: (1) provide financial assistance to unemployed workers and their families and (2) stabilize the economy during economic downturns. The UI system is sometimes called the Unemployment Compensation (UC) program, and UI benefits are also called unemployment compensation.
The Birth Of America’s Unemployment Insurance System
After the stock crash of 1929, the United States entered a gloomy economic period now known as the Great Depression. Workers were laid off from factories in unprecedented numbers. These unemployed workers did not have the income to spend on basic necessities for themselves and their families. Without the working class spending on consumer goods and services, the economy spiraled downward and more people lost their jobs.
Economists, politicians, corporations, and labor groups from every corner of the political spectrum debated over what policies could turn things in the right direction. Then in 1932, with the United States deep in the Great Depression, the Wisconsin state government passed the nation’s first unemployment insurance law.
President Franklin Delano Roosevelt recruited economists from Wisconsin to help develop a set of national programs that became the Social Security Act (“SSA”) of 1935. The SSA turned out to be what many say is the most important piece of Roosevelt’s “New Deal.” The SSA established an insurance system to provide, among other things:
Universal retirement pensions for people who reach a specified age (i.e. social security payments);
A set of welfare benefits to assist disabled people and needy children without a father present in the family; and
A joint federal-state insurance program to provide financial assistance to workers who meet certain eligibility requirements.
Since the SSA was passed in 1935, there have been many changes to the UI system through amendments and new laws passed at both the federal and state levels. Let’s take a look at how the UI system works in its current form.
The Roles Of Federal And State Governments
The UI system is referred to as a federal-state program because it is rooted in federal law but each state administers the program with state employees and state laws.
The two main federal laws relating to the UI system are the SSA and the Federal Unemployment Tax Act (FUTA). The SSA and the FUTA established the basic requirements for states and the federal government. The main duties of the federal government are to:
Set the general policies for states to use in running the UI programs;
Make sure the states’ laws, regulations, rules, and administration of the UI program are all in accordance with the relevant federal laws and regulations;
Provide the states (at least those states that meet minimum federal requirements) with federal grants to pay the administrative costs of running the UI program;
Monitor and provide technical assistance to the states when needed; and
Hold and invest the unemployment trust fund until the states use it for UI benefits payments.
The states all run their own UI programs in different ways. Anyone interested in learning more about a particular state’s program should contact the relevant agency in that state. Within the federal-state joint program, it is the role of each state to:
Create laws, regulations, and/or rules regarding:
which unemployed workers are eligible for benefits and which are disqualified (i.e. the state’s benefit structure) and
the state’s Unemployment Insurance tax rates and taxable wage base;
Determine how it will administer the UI program (and then administer the program accordingly);
Process UC claims from individuals and pay benefits to eligible workers;
Determine employer liability and collect the appropriate employer contributions to the unemployment compensation fund.
Finding The Money That Pays For Unemployment Insurance
The UI system is funded through taxes at both the state and federal level. This section examines the role that each level plays in collecting taxes and funding different parts of the UI program.
Federal Unemployment Insurance Taxes
According to the federal government’s workforce security website:
“FUTA taxes are calculated by multiplying 6.0% times the employer’s taxable wages. The taxable wage base is the first $7,000 paid in wages to each employee during a calendar year. Employers who pay their state unemployment taxes on a timely basis receive an offset credit of up to 5.4% regardless of the rate of tax paid to the state. The FUTA tax rate for employers in states not subject to a FUTA credit reduction is generally 0.6% (6.0% – 5.4%), for a maximum FUTA tax of $42.00 per employee, per year (.006 X $7, 000 = $42.00).”
The federal government does not use its UI tax revenue to pay the ordinary unemployment compensation benefits that individuals receive. Instead, the federal government uses its UI tax revenue to do the following:
Pay for states’ unemployment compensation program administrative costs;
Fund a loan fund that states can borrow from when they don’t have the funds to pay unemployment compensation for a given month; and
Help fund unemployment compensation for supplemental, emergency, and extended benefits in certain circumstances (under the Federal-State Extended Unemployment Compensation Act of 1970).
State UI Taxes
States impose UI payroll taxes on employers (also known as “employer contributions”) and use the revenue to finance the cost of paying out UI benefits to eligible unemployed individuals. As a side note, Pennsylvania, New Jersey, and Alaska are the only states that apply some UI tax directly to employees in certain circumstances.
Every state has its own account within the federal Unemployment Trust Fund. States pay into their Unemployment Trust Fund accounts using state UI payroll tax revenue. When a state does not have enough money to pay UI benefits, the state can borrow from the federal Unemployment Trust Fund. During the recent Great Recession, most states had to borrow from their federal trust fund accounts to keep their UI programs running. Many states still have outstanding loans on these accounts.
How Are State UI Taxes Determined?
The amount of state UI taxes that employers pay can vary significantly from state-to-state and company-to-company. The state UI tax rate is commonly referred to as the employer’s “contribution rate.” State UI taxes are typically determined based on:
The number of employees that work for the employer;
The taxable wage base, as set by the state; and
The applicable contribution rate, which is assigned to the employer based on its “experience rating.”
FUTA requires states to have a taxable wage base of at least $7,000 per employee per calendar year. Some states set their taxable wage base at exactly $7,000, but most state UI laws set a taxable wage base at a greater amount. Washington state currently has the highest taxable wage base at $39,800. Because of the way a taxable wage base works, employers in Washington will not have to pay the state’s UI tax on any wages beyond the first $39,800 per employee per year. A list of current and recent taxable wage bases for all states is available here.
An employer’s experience rating is basically the employer’s track record with regard to laying off workers who then get UI benefits. The purpose of the experience rating system is to vary an employer’s contribution rate based on the degree of risk that their employees will end up needing UI benefits. As a result, employers who have a history of stability have lower contribution rates than employers who are likely to let go of workers who tap into UI benefits. In this respect, the UI system reflects the normal theory behind insurance systems: higher risk of a claim requires a higher payment for the insurance policy.
In most states, newer employers (during the first few years of business) have a standard/default contribution rate. This is because new employers do not have enough operating history to determine credible experience rating. To use a baseball metaphor, you can’t reliably predict whether a major league rookie is a great hitter or a terrible hitter if you’ve only seen his first few swings – you need a decent sample size.
States may also occasionally make changes to their schedule of contribution rates based on the balance of the state’s account in the federal Unemployment Trust Fund. If a state needs to pay back a federal loan, it can decide to acquire the necessary funds by increasing the contribution rates paid by employers. If a state finds that it has more money than it needs in the account, it may choose to lower the contribution rates paid by employers.
Which employers and which workers are fall within UI law?
The issue of who is covered by UI laws is very important for both employers and workers. If employers fall within UI law coverage, they are liable for UI contributions. At the risk of stating the obvious: most business owners do not want to pay UI taxes unless they legally have to. If workers are covered by UI law, they accrue UI benefit rights (and workers generally would rather accrue rights to benefits than not).
According to a publication from the U.S. Department of Labor, to determine whether or not the services performed by a given worker are covered by UI law, the following four questions must be answered:
Were the services performed for an employer?
Were the services performed in an employer-employee relationship?
Were the services performed in employment?
Were wages paid for the services?
The services (and the worker and employer) are covered by UI law if all four questions are answered with a “yes.” The details of how these questions are evaluated varies between the states, but there are many commonalities. See the above mentioned Department of Labor publication for more information on how these four questions are approached by each of the states and the federal government.
One issue that commonly arises is the categorization of a worker as an independent contractor as opposed to an employee. If a person performs services as an independent contractor, then the work situation is not covered by UI laws (which businesses generally appreciate). An independent contractor does not accrue UI benefits and the employing unit does not have to pay UI taxes on the payment exchanged for the services. The federal and state UI laws contain specific tests to determine whether someone is technically an employee or an independent contractor.
Most states use a three-part test called the “ABC” test for independent contractors. The ABC test dictates that a worker is an employee (not an independent contractor), unless he meets the following three criteria:
The worker is free from control or direction in the performance of the work under the contract of service and in fact;
The service is performed either outside the usual course of the business for which it is performed or is performed outside of all places of business of the enterprise for which it is performed; and
The individual is customarily engaged in an independent trade, occupation, profession, or business.
Although the ABC test is the most common independent contractor test, there are variations on this test in some states. For details on each state’s test, check out Table 1-4 in the Department of Labor publication.
Why Does Unemployment Insurance Funding Come From Payroll Taxes?
During the development of the SSA, Roosevelt specifically insisted that the funds for the UI system come from payroll taxes, not from sales taxes or the government’s general fund. As Roosevelt somewhat famously explained:
“We put those pay roll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions and their unemployment benefits. With those taxes in there, no damn politician can ever scrap my social security program. Those taxes aren’t a matter of economics, they’re straight politics.”
Many economists believe that the UI tax burden ultimately impacts employees, even if the employers are handing over the tax revenue to the states. These economists reasons that the employers who pay the UI tax would otherwise be paying those tax dollars to the employees for their work. This economic theory is consistent with Roosevelt’s belief that the UI program could not be attacked as a “handout” because the workers themselves contribute to the insurance funds and thus they have a right to collect from the fund if they need to.
Who Is Eligible To Receive UI Benefits?
In order to collect unemployment insurance benefits, the unemployed worker must be “eligible.” As with most of the UI system, the federal government gives the states broad guidelines for determining eligibility and the states’ requirements vary within these federal guidelines. According to a Department of Labor summary, two of the requirements for eligibility are:
You must meet the State requirements for wages earned or time worked during an established period of time referred to as a “base period”. (In most States, this is usually the first four out of the last five completed calendar quarters prior to the time that your claim is filed.)
You must be determined to be unemployed through no fault of your own (determined under State law), and meet other eligibility requirements of State law.
Another requirement is that the person is “able to work, available to work, and actively seeking work.” The states require different forms of documentation to show that a person is actively seeking work, such as a weekly job search log that lists the applications submitted and interviews attended. Individuals considering applying for benefits should speak with their state’s unemployment benefits agency to learn their specific eligibility requirements.
How Much Financial Assistance Do UI Benefits Actually Provide?
UI benefits are intended to provide eligible individuals with a temporary, partial wage replacement. The benefits can hopefully help with purchasing basic necessities between jobs. Depending on a number of factors, a person’s benefits can vary in terms of the weekly dollar amount received and the number of weeks that benefits are received.
For most states, the weekly benefit amount is supposed to be about half of the worker’s weekly earnings when they were employed. Although the duration of benefits can be extended during harsh economic times (e.g. the Great Recession), most states allow benefits to be provided for a maximum of 26 weeks. The actual durations and amounts of benefits are calculated differently by each state’s UC program. Recently, the national average weekly benefit amount was about $300. The national average duration of benefits was just under 17 weeks. The federal government’s workforce security website provides quarterly updates regarding benefit amounts and durations.
So, if you find yourself unemployed, don’t fret. After almost 80 years in existence, the UI system is still an evolving federal-state partnership. The UI system remains a crucial stabilizer for the national economy and an important example of the nation’s support of workers and their families through tough times. The economy and the UI system have undergone many changes since the system was established in 1935. Despite these changes, the UI system continues to be a relevant and important commercial insurance program for employees, employers, and the country at large.
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