Expand the Federal Unemployment Tax Act Base and Make the Unemployment Insurance Surtax Permanent
Unemployment insurance (UI) is financed by a combination of federal and state taxes that are levied on employers and based on the wages of each employee. The Federal Unemployment Tax Act (FUTA) currently imposes a federal payroll tax on employers of 6.0 percent of the first $7,000 of annual wages paid to each employee. The tax funds a portion of the federal/state unemployment benefits system. Before its expiration on July 1, 2011, the Federal payroll tax had included a surtax of 0.2 percentage points, which started in 1976 and had been extended until then. The Administration proposes reinstating the surtax and making it permanent, which would raise $13.9 billion from 2013-2022.
State-level governments may set their taxable wage base separate from the federal base. Currently, only three (Arizona, California, and Puerto Rico) match the federal base, which was established in the 1980s and has not been indexed to wage growth. The remaining states and the District of Columbia have set their taxable wage bases at higher levels and often automatically adjust their bases for inflation. Employers in states that meet certain federal requirements are allowed a tax credit for state unemployment taxes up to 5.4 percent of the federal wage base—that is, the minimum net federal tax rate is 0.6 percent, without the extension of the Federal payroll surtax. The administration proposes extending the surtax
Due to the length of the current downturn and the relatively low levels of state reserves at the beginning of the recession, states have accrued a large level of debt to the federal UI trust fund. When states have exhausted their funds and borrow from the federal government to pay benefits, they are required to repay both the principal and interest. Thus, net federal tax rates on employers increase in indebted states (since they are not eligible for the full credit) to repay the loans. Affected states also must increase state payroll tax rates or the covered wage base to rebuild their funds. In addition, states may address their short-term debt burden by limiting eligibility or benefits paid to unemployed workers.
Employers in some indebted states have faced higher taxes to repay these debts, which arguably discourages job creation. To mitigate this obstacle to economic growth, the President’s budget proposes to provide short-term relief to employers by suspending interest payments on state UI debt and suspending the FUTA credit reduction for employers in borrowing states in 2012 and 2013. Additionally, the Administration would raise the annual FUTA wage base to $15,000 per worker in 2015, index the wage base to subsequent wage growth, and reduce the net federal UI tax from 0.8 percent (which includes its proposed surtax) to 0.37 percent. States with wage bases below $15,000 would have to conform to the new FUTA base. States would retain the ability to set their own tax rates, as under current law. The Administration estimates that this proposal would cost $6.6 billion in 2013 and 2014, but the higher tax base would increase revenues starting in 2015. From 2013-2022, the proposal would raise $47.8 billion.
Given the slow economic recovery and the current state of the unemployment insurance funds, the timing of the proposals makes sense: postponing an increase in unemployment taxes can encourage new hiring and increasing the wage base will help many states accumulate fund balances, shoring up their reserves for the next recession. In addition, indexing the wage base for the wage growth will prevent future erosion of unemployment funds by inflation.
U.S. Department of Labor, “UI Data Summary FY 2012 Budget Mid-session Review.”
Center for Budget and Policy Priorities, “Rebuilding the Unemployment Insurance System.”