oversight

Unemployment Insurance: Trust Fund Reserves Inadequate to Meet Recession Needs

Published by the Government Accountability Office on 1990-05-31.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

    l ’
                 United   States   General   Accounting   Office

GAO              Report to the Acting Chairman,
                 Subcommittee on Human Resources,
                                                                   .
                 Committee on Ways and Means, House
                 of Representatives

May 1990
                 UNEMPLOYMENT
                 INSURANCE
                 Trust l?und Reserves
                 Inadequate to Meet
                 RecessionNeeds




GAO/HRD-90-124
 c



                 United States

GAO              General Accounting  Office
                 Washington, D.C. 20548

                 Human Resources        Division

                 B-239714

                 May 31, 1990

                 The Honorable Thomas J. Downey
                 Acting Chairman, Subcommittee on Human Resources
                 Committee on Ways and Means
                 House of Representatives

                 Dear Mr. Chairman:

                 This report responds to your request that we examine proposals con-
                 tained in H.R.3896, the Unemployment Compensation Reform Act of
                  1990. Specifically, you requested that we assess

             l the likely effect that a future recession would have on (1)reserve bal-
               ances in the state trust funds and (2) state borrowing,
             l the ability of the federal Unemployment Insurance (c’I) accounts to meet
               the needs of states in a future recession, and
             . the likely effect that a proposed increase to the taxable wage base and
               modifications to the extended benefits program would have on the
               financial status of the UI system.l

                 We used projections, from the Department of Labor’s Unemployment
                 Insurance Service state loan model,z to assess the impact of a severe
                 recession, similar to the 1981-82 recession, on the financial status of the
                 UI system. Labor developed the projections at our request. Our analysis
                 assesses the system under three policy conditions-( 1) the current pro-
                 gram funding structure, (2) this structure with an increase in the tax-
                 able wage base starting in 1991, and (3) this structure with an increase
                 in the taxable wage base together with changes to the Extended Benefits
                 Program as called for in the bill. To determine the effect of an increase
                 in the taxable wage base under an actual recession, we also used Labor’s
                 model to assess the outcome had this change been implemented in 1978.
                 before the recessions of the early 1980s.


                 The principal purposes of the UI program are to (1) provide a cash ben-
Background       efit to those who are temporarily unemployed and (2) help stabihze the
                 economy during a recession by providing the unemployed with a portion

                 I The Extended Benefits Program provides up to an addmoral 13 weeks of UI benefits 111<iwii\ (I!
                 high unemployment. These modificatmns would, m part, lower the level of unemploymrnr rwd~~l ior
                 states to begin paying extended benefits.

                 ’ This model produces fiscal year estimates of wegate trust fund balances. loans and ~~~~,~~TwIIL~
                 loan balances, reduced federal UI tax credits, interest earning.... and Lnterest pad.



                 Page 1                                 GAO/lfiUX#124      Unemployment Insurance TNS t’nnds
B-239714




still owe the federal UI loan account $10.7 billion 5 years after the start
of the recession. The federal UI loan account would be exhausted by the
state loans, and general fund advances of $6.6 billion would be required.

This situation could result in state actions similar to those taken in the
1980s to become solvent, that is, making it more difficult for people to
qualify for benefits, reducing the duration of such benefits, and
increasing employer taxes. But these actions, in our opinion, jeopardized
the program’s principal purposes of providing cash benefits to the
unemployed and helping to stabilize the economy during a recession.

An increase in the taxable wage base would be a step toward returning
to a forward-funded CI program, but by no means would it result in this
feature being fully restored immediately. On the basis of our analysis
using Labor’s model, states would need to borrow $3 billion less from
the federal loan account and would owe $4.2 billion less after 5 years. In
addition, the federal loan account would need $2.2 billion less in
advances from the general fund.

To further illustrate the impact that an increase in the taxable wage
base would have on UI trust fund reserves, we simulated what would
have occurred had such a change been introduced in 1978. To do this.
we used the actual economic circumstances that existed from the start
of 1978 through the end of 1983, as well as the balances of the federal
and state accounts at the beginning of that period. The overall effect
would have been a $21 billion change in the financial status of the 1.1
system by 1983-from minus $25 billion to minus $4 billion. Thus. the
UI system would have been better off financially following the severe
recessions of the 1980s.

Labor’s model indicates that an increase in the taxable wage base. cou-
pled with the lowering of the statewide level of unemployment needed
to qualify for extended benefits, would produce similar but less dra-
matic results. These projections indicate that there would be $1.1 billion
less in state borrowing during a recession than under current law and
$3.3 billion less in outstanding loans at the end of 1995. Yet, 18 states
would become insolvent. At the same time, the UI program would have
paid out about three times as much in extended benefits as under cur-
rent law-$17 billion compared with $6.2 billion.

The effects of a severe recession on the UI system under each of the
three policy conditions are summarized in table 1.



 Page 3                        GAO/HUD9&134   Unemployment Insurance Trwt Funds
B-239714




Our work was carried out between October 1989 and April 1990. We
testified on the preliminary results before your Subcommittee in Feb-
ruary 1990.5 As agreed with your office, we did not obtain written com-
ments from the Department of Labor but consulted with agency officials
to ensure that our use of data from Labor’s model was technically
correct.

Copies of    this report will be sent to the Secretary of Labor and other
interested    parties. Please call me on (202) 275-1793 if you or your staff
have any     questions about this report. Major contributors are listed in
appendix     V.

Sincerely yours,




Franklin Frazier
Director, Education
  and Employment Issues




’ Unemployment Insurance: Comments on H. R. 3896, The Unemployment timpensatwn   Hd~rm .-\ct
of 1990 (GAO/T-HRDSO - 15 Feb. 22, 1990).



Page 5                               GAO/HRD90124     Unemployment Insurance Trust    Funds
Table 111.3:Increased Taxable Wage Base and Changes to                     17
    Extended Benefits




Page 7                      GAO/HltD9iSl24   Unemployment Insurance Trust Funds
declining activity. This approach was followed consistently during the
first three decades after the program’s inception in 1935. Increasingly.
however, many states have not accumulated reserves sufficient to cover
benefits during recessions and, instead, have relied on federal loans to
sustain their programs during these periods.

The federal loan account was established in 1954 to provide advances to
state programs that otherwise would become insolvent and be unable to
make benefit payments. The expectation was that the states would
repay these loans from future payroll tax revenue when the economy
recovered. Initially, these loans were interest free, essentially providing
(1) a subsidy to debtor states and (2) little incentive for states to repay
loans or to build trust fund reserves to meet future needs. Beginning in
1982, however, the federal government haa charged interest on these
loans.

A number of state trust funds became insolvent in the past, and this
number has increased over the years-from      1 in 1972, 13 in 1975. and
23 in both 1982 and 1983. Loans to state trust funds have been quite
large, necessitating general fund advances from time to time. State UI
trust funds have borrowed about $29.6 billion to pay benefits-
$11.8 billion in loans were needed during 1982-83 alone. Overall, this
has resulted in negative balances in the UI system, evidence that the pro-
gram was not forward funded. As shown in table 1.1, during the 9 con-
secutive years from 1976 to 1984, the total balance of the three federal
accounts and 53 state accounts was negative. The total balance for the
three federal accounts was negative for 12 consecutive years, from 1975
to 1986.




Page 9                         GAO/HIlBW124   Unemployment Insurance Trust Funds
Appendix I
Detailed Background




actions have included an increase in employer LI taxes while unemploy-
ment rates were still high, tightening the requirements for 1.1benefits,
and reducing the length of such benefits.




 Page 11                      GAO/HRL%9@124   Unemployment   lnswancr   Tru~bl Funds
                                         Overall, the system had a high-cost multiple of .89 as of December 1989,
                                         meaning about 11 months of recession benefits were in reserve. This is a
                                         considerable improvement over the .07 high-cost multiple in 1984.

                                         The results of a simulated severe recession, using Labor’s model and the
                                         equivalent of the 1981-82 recession, are shown in table 11.1.The model
                                         indicates that if such a recession was to begin in 1991, the states would
                                         need to borrow about $17.4 billion from the federal loan account for
                                         1991 to 1996. Moreover, 17 state programs would become insolvent,
                                         with negative balances in their trust funds at the end of 1 or more years
                                         during this period. Of these 17 insolvent states, 15 had a high-cost mul-
                                         tiple below 1.0 before the simulated recession. At the end of 1995, the
                                         states would owe about $10.7 billion and the net balance of the state
                                         trust funds (balances of state trust fund minus outstanding loans) would
                                         be $16.5 billion. The federal loan account would have an estimated bal-
                                         ance of $2.3 billion at the start of 1991, but this amount would be insuf-
                                         ficient to meet state loan requirements. The federal loan account would
                                         need advances of $6.6 billion from the general fund.

Table 11.1:Effocta of Swore Recession
Under Current L~irlation (Fiscal Years   Dollars in billions
1991 Through 1995)
                                         State borrowma                                                                              $17 4
                                         General fund advances to loan account                                                         66
                                         State loan balances. end of 1995                                                             107
                                         Net state UI balances, end of 1995                                                           165
                                         Note: The number of insolvent states IS 17



                                         The original act establishing the UI system imposed a federal UI payroll
Effect of a Taxable                      tax on the total annual wages paid employees. A legislative change in
WageBase Increase                        1939, however, imposed the federal tax on the first $3,000 of annual
                                         wages; this tax has been limited to a portion of annual wages ever since.
                                         The wage base has not kept pace with the growth in wages. Had the
                                         1939 ceiling been continually indexed to wage inflation, the current
                                         ceiling would be over $42,000. The gap between the wage base and wage
                                         growth has been allowed to exist because revenues based on a lower
                                         wage base were more than ample to cover benefit payments to the
                                         unemployed through the 1960s. The taxable wage base was
                                         subsequently increased three times-to       $4,200 in 1970, $6,000 in
                                          1976, and $7,000 in 1982.




                                         Page 13                                      GAO/HIUbSlW24   Unemployment   In&nuance Trust hnds
                                         Appendix II
                                         Itesulta of GAO Analysis




Table 11.2:Effects of Severe Aeces8ion
Under Current and Proposed Legislation   Dollars m billions
(Fiscal Years 1991 Through 1995)
                                                                                                                                increased
                                                                                                          Current law          wage base
                                         State borrowmg                                                            $174              $143
                                         General fund advances to loan account                                      $66               $44
                                         State loan balances, end of 1995                                          $10 7              $65
                                         Net state UI balances. end of 1995                                        $16 5             $291
                                         Insolvent states                                                              17               16


                                         Had the taxable wage base increase been implemented starting in Jan-
                                         uary 1978 (before the recessions of the early 198Os), the system would
                                         have been better able to handle the subsequent severe recessions. Using
                                         the Labor model, we estimate that with an increase in the taxable wage
                                         base, the net balance of state trust fund reserves at the end of 1983
                                         would have changed from minus $5.8 billion to a positive $4.9 billion, a
                                         difference of $10.7 billion. Equally dramatic changes would have
                                         occurred in the federal accounts, with their net balances increasing by a
                                         total of %10.3 billion. The simulation results show that the overall effect
                                         of the wage base increase, had it been introduced in 1978, would have
                                         been a $21 billion change in the financial status of the UI system by
                                          1983-from minus $24.5 billion to minus $3.5 billion (see table 11.3).

Table 11.3:Effect of Increased Taxable
Wage Base (1978-M)                       Dollars in bllllons
                                                                                                   Balances
                                                                                                                  With
                                                                                                  1983      increased
                                                                                                 actual    waae base            Difference
                                         Federal accounts                                        -$187           - -.$a4             $103
                                         State accounts                                            -50                49              107
                                         Total UI system                                         -524.5            -53.5             $21.0



                                         In addition to increasing the taxable wage base, the proposed legislation
Effect of Increased                      would, among other things, change the circumstances under which fed-
Taxable Wage Base                        eral-state extended benefits would be paid. UI beneficiaries are normally
and Revised Extended                     eligible for a maximum of 26 weeks of benefits and the Extended Bene-
                                         fits Program prolongs worker eligibility for UI benefits for up to an addi-
Benefits                                 tional 13 weeks in areas of high unemployment. Extended benefits are
                                         paid after state unemployment rates reach specific levels. At present,
                                         mandatory benefits are paid to eligible recipients when a state’s Insured
                                         unemployment rate (1) equals or exceeds 5 percent for 13 conswutl~e


                                          Page 16                                GAO/HRD90-124    Unemployment     Insurancr   Trust Funds
Appendix III

Simulation Results


Table 111.1:Current Funding Structure
                                        Dollars In blhons                                                                _____
                                                                        1991      1992     1993    1994      1995                  Total
                                        State borrowing from federal
                                        loan account                     14        59       40      32          29                     17.4
                                        General fund advances to
                                        federal loan account               0       34       26        6           0                     6.6
                                        State loan balances. end of
                                        year                              17       73      10.1     10 9       10 7                           a
                                        Net state UI balances. end of
                                        year                            227        77       6.8     106        165                            .

                                        aNot applicable.

Table 111.2:Increased Taxable Wage
Base                                    Dollars In blllions
                                                                        1991      1992     1993    1994       1995         __-     Total
                                        State borrowing from federal
                                        loan account                      14       5.3      35       21         19                     14.3
                                        General fund advances to
                                        federal loan account               0       2.9       15        0          0                     4.4
                                        State loan balances, end of
                                        vear                              1.7      68       8.3      8.1        65                             a
                                        Net state UI balances, end of
                                        vear                             22.7      9.2      11 6    19 1       29 1                               I

                                        “Not appkable

Table 111.3:Increased Taxable Wage
Base and Changes to Extended Benefits   - - -. - m -hdlinnc
                                        OnHare           - -                                                                     -__
                                                                        1991      1992     1993    1994       1995                     Total
                                        State borrowing from federal
                                        loan account                      14        6.0      4.5     2.4        20                       6.3
                                        General fund advances to
                                        federal loan account                  0     42       16          0           0                   5.8
                                        State loan balances, end of
                                                                                                                                                  I
                                        year                              1.7       74       9.2     89          74
                                        Net state UI balances, end of
                                        year                             213        63       77     144        23 6                               a

                                        “Not apphcable




                                        Page 17                            GAO/HlUWX%l24    Unemployment     Insurance     Trust Funds
Major Chributors to This Report


                         Sigurd R. Nilsen, Assistant Director, Employment and Training Issues,
Human Resources            (202) 523-8’701
Division,                Thomas N. Medvetz, Assignment Manager
Washington, D.C.

                         Anders T. Anderson, Evaluator-in-Charge
Boston Regional Office
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RelatedGAO Products


             Unemployment Insurance: Comments on H.R. 3896, The Unemployment
             Compensation Reform Act of 1990 (GAO/T-HRDSO-15, Feb. 22. 1999).

             Unemployment Insurance: Administrative Funding Is a Growing
             Problem for State Programs (GAO/HRD-89-72BR, May 24, 1989).

             Unemployment Insurance: Administrative    Funding Likely a Growing
             Problem (GAO/T-HRD-8921, May 24, 1989).

             Unemployment Insurance: Trust Fund Reserves Inadequate    (GAO/
             HRD&%55,Sept. 26, 1988).

             Unemployment Insurance: Issues Related to Reserve Adequacy and
             Trust Fund Solvency (GAO/T-HRDBS~, July 7, 1988).

             Unemployment Insurance: Issues Related to Reserve Adequacy and
             Trust Fund Solvency (GAO/T-~~~-886, Dec. 14, 1987).
Appendix IV

EconomicAssumptions Used in Recession
Simulation

                                                         1990   1991   1992      1993   1994    1995
              Total unemployment rate (percent)           57      90    102        76     73      7c
              Ciwllan labor force growth (percent)          6     15     14        12     14      12
              Waae arowth (oercent)
                 -1
                                                          56      61     59        53     47     ~45
              Clwllan employment   (mdllons)             1173   1149   1150---   1196   ‘21 9    ~~ 6
                                                                                                123




                  -   1                              .
Appendix ll
RemIts of GAO Analysis




weeks and (2) is at least 20 percent higher than the average rate for the
same 13-week period in the preceding 2 years.’ At the state’s option,
benefits can also be paid when the insured unemployment rate reaches 6
percent, regardless of previous unemployment rates.

The proposed legislation would reduce the current insured
unemployment rates by 1 percentage point, to 4 percent for the man-
datory benefits and to 5 percent for the optional payments. The pro-
posed legislation would also allow extended benefits to be paid when
a state’s total unemployment rate equals or exceeds 8 percent during
the previous 12month period.

Again using Labor’s model, we simulated the effect the above changes in
the Extended Benefits Program, coupled with an increase in the taxable
wage base, would have on the financial condition of the federal accounts
and the state trust fund accounts. This simulation showed that under a
severe recession, beginning in January 1991, a total of about $17.0 bil-
lion in extended benefits would be paid to UI claimants for 199 1 through
 1995, compared with about $6.2 billion under existing law. Under this
simulation, states would have to borrow about $16.3 billion from the
federal loan account and 18 state programs would become insolvent
during this period. At the end of fiscal year 1995, the states would still
owe about $7.4 billion. The net balance of the state trust funds would be
$23.6 billion. As in the other two simulations, the balance in the loan
account would be insufficient to meet loan requirements-$5.8      billion in
advances would be needed from the general fund. These results, along
 with those from simulations using the current funding structure and an
increase in the taxable wage base, are summarized in table 1.1 (see p. 4).




? The mured unemployment rate 1sthe number of regular UI benefit clmams dir ldt,d t)? ‘hi
average number of people in IT covered employment for the first 4 of the last 6 nrmplt~r~~d.hndar
quarten.



Page 16                                 GAO/HUBS@124 Unemployment lnsurancr TNIL             Funds
Appendix U
Results of GAO Analysis




H.R. 3896 would increase the taxable wage base from its current JT’.OOU
to $10,000, with $l,OOU increments over 3 years. Thereafter. the wage
base would be indexed to the growth in average annual covered >vages.
This change, coupled with the expiration of the .2 percent temporary
surtax at the end of 1990, would generate a federal employrr 1.1tax of
$48 in the first year (compared with $56 under current lal, $54 in the
second year, and $60 in the third year for each employee     rung the
base wage or more. Our analysis assumed that the .2 perct 1: surtax
expired at the end of 1990.

An increase in the taxable wage base will generate increased revenue for
the federal trust fund accounts and increase reserves in some of the 53
state trust fund accounts. Only the 17 state trust funds with a taxable
wage base at the current level of $7,000 will, however, receive the full
amount of increased revenues generated by this proposal. Of the
remaining states, 19 already have a wage base of $10,000 or more and
 17 have a wage base of between $8,000 and $10,000. In an attempt to
offset the effect of a taxable wage base increase, the states have. m the
past, reduced the rate at which they tax employers following these
increases. To the extent that this would again occur following the imple-
mentation of the wage base proposal, the increase in state trust fund
reserves would be reduced. Labor’s model includes, to some t ‘pnt,
reductions in state tax rates that traditionally have accomp;’ d
increases in the taxable wage base.

Simulation results, based on Labor’s model and assuming a st- w reces-
sion, coupled with an increase in the taxable wage base beginnmg in
January 1991, are shown in table 11.2.According to Labor’s model, this
condition would result in states’ needing to borrow $14.3 billion from
the federal loan account for 1991 to 1995. This would amount to $3 bil-
lion less than under current law. At the end of 1995, the states would
owe about $6.5 billion ($4.2 billion less) and the net balance of the state
trust funds would be $29.1 billion-$12.6     billion more than under
existing law. The federal loan account would need advances of S-l 1 bil-
lion from the general fund-$2.2 billion less than under the curr~~nt
funding structure. Sixteen states would become insolvent berwvetn 199 1
and 1995 under this condition, compared with 17 under the eslstmg
condition.




 Page 14
Appendix II

Resultsof GAO Analysis


                    Our analysis indicates that (1) many states may not have reserves suffi-
                    cient to pay recession benefits and (2) the current financial condition of
                    the UI system, overall, appears to be inadequate to handle a severe
                    recession. This is so despite 7 years of economic expansion and reserves
                    of $8.1 billion in the federal accounts and $36.2 billion in the state trust
                    fund accounts as of January 1990. Our analysis also indicates a severe
                    recession in the near future would most likely result in states’ borrowing
                    from the federal loan account in order to pay benefits to the unem-
                    ployed. In addition, financing these federal loans would probably again
                    require general fund advances.

                    Our analysis compared the UI system’s ability to handle a severe reces-
                    sion under the current funding structure with its ability under an
                    increase in the taxable wage base. In general, our analysis showed that
                    this increase would be a step in the right direction, toward restoring the
                    forward-funding basis of the UI system. But by no means would this
                    increase result in the full restoration of forward funding in the imme-
                    diate future.


                    The most commonly used measure of the adequacy of financial reserves
Current UI System   is known ‘s the high-cost multiple. This measure compares current
ReservesAre         reserves      .1peak benefit payouts in the past. It is essentially an indi-
Inadequate          cator of kt. long recession benefits could be paid from current reserve
                    balances. An association of state employment security agency adminis-
                    trators has endorsed a target high-cost multiple of 1.5 as being indica-
                    tive of reserve adequacy; this means there should be 18 months worth
                    of benefits in the state trust fund in order for a state to go through a
                    recession without needing loans. Judged by this measure, resemes today
                    are inadequate. As of December 1989, only 7 of the 53 state programs
                    had a high-cost multiple at or above the 1.5 standard. In contrast, 39
                    states had a high-cost multiple above 1.5 in 1969.

                    A 1986 study undertaken for the Department of Labor concluded that
                    state reserves would usually be adequate at high-cost multiples as low
                    as 1.0.’ Using this less stringent standard adds an additional 17 states to
                    the list of 7 with sufficient reserves; however, 29 states would still have
                    inadequate reserves according to this standard. In 1969, 51 of the 53
                    state trust funds surpassed the 1.0 standard.


                    I An Analysts of UI Trust Fund Adequacy, Vroman. Wayne and Bamow. Burt. Lnemplii~mrvt !mur-
                    mce Service Occas~onaIPaper 87-I (Dec. 1986)



                    Page 12                              GAO/HBD6@124      Unemployment
                                                                                     lnsuranreTruerFunds
                                           Appendix     I
                                           Detailed    Back@wund




Table I: Financial Status of UI Accountr
(1970-89)                                  Dollars in bflllons
                                                                                                                           Total                               UI
                                                                                                                         federal                         system
                                           Year                     liSAAn             EUCAb             FUAC          accounts           State             total
                                           1970                          06               $0                $6                      7     $1’ 9            $126
                                           1971                              2           - 04                   6                   8        97           -10:
                                           1972                              3             -6                   5                   2        94              96
                                           1973                              5             -7                   5                   3       lC5              10 8
                                           1974                              7           -04                    5                   8       105              113
                                           1975                              4           -13                01                 -9            31                  22
                                           1976                              5           -62              -24                 -81                  9             72
                                           1977                              2           -84              -38               -120                   9        -11 1
                                           1978                              3           -81              -47               -125             46              -7 9
                                           1979                              6            -71             -44               -109             86                  23
                                           1980                              8            -65             -39                 -96            66              -3 0
                                           1981                              8            -64             -55               -11     1        5a                  53
                                           1982                              5            -63             -79               -137            -26             -16 3
                                           1983                              3            -61            -129               -187            -58              24 5
                                           1984                              9            -41             -91               -123              22             101
                                           1985                             IO            -22             -57                 -69            101                 32
                                           1986                             11             -7             -41                 -37            154             11 7
                                           1987                        --1 6                13            -23                       6       22 9             235
                                           1988                             19              3.6                  1                56        31 1             367
                                            1989                      --I        1          58              1.7                   82        36 7             44 9

                                           YSAA       Employment Security Adminstratlon           Account(prowdes      funds for adm~nlstrat:ve CCSIS,

                                           QEUCA Extended Unemployment               Compensation     Account(prwdes       funds for extended be@ ‘91

                                           ‘FUA Federal Unemployment Account (prowdes loans to states)
                                           Note The balances of EUCA and FUA conslstof the end of-the-year balance mrws generai ‘~vd
                                           advances The slate account balance conststs of end-of-the-year balance nxnus all
                                           outstanding federal loans


                                            The Congress enacted several policy changes in the late 1970s and early
                                            1980s that were designed to move the system toward a positive total
                                            reserve balance and restore the forward-funding basis of the program.
                                            These included the 0.2 percent federal surtax on employers and the
                                            charging of interest on federal loans to state trust funds. The larrer
                                            change had the intended effect of expediting state repayment of ftderal
                                            loans. In an attempt to reduce funds spent on UI benefits, howcl,er.
                                            many states took actions that ran counter to the principal purp)st’s of
                                            (1) providing the unemployed with a cash benefit while out of L\or-k and
                                            (2) stabilizing the economy during periods of recession. In the pa.\t. rhe
Appendix I

Detailed Background


              The Unemployment Insurance (61) program is the federal gov,ernment‘s
               major means of providing income maintenance assistance to the unem-
               ployed. The program’s principal purposes are to provide (I) individuals
               with temporary and partial wage replacement when they have lost their
              jobs and (2) countercyclical stabilization of the national economy during
               an economic decline by maintaining the purchasing power of the
               unemployed.

              The CTIsystem includes 3 federal accounts and 53 state accounts. The
              federal accounts are financed through a payroll tax on employers; they
              provide funds for state and federal UI program administration. one-half
              of an Extended Benefits Program (this program lengthens the period
              over which VI benefits are paid in areas of high unemployment), and
              loans to states with insolvent UI accounts. The state accounts are also
              funded through a payroll tax and are used to finance regular GI benefits
              and one-half of an Extended Benefits Program. Each state operates its
              own UI program, levying and collecting its own payroll tax and, within
              certain limits, determining the amount of benefits and the conditions for
              benefit eligibility. As a result, tax rates, benefit amounts, and trust fund
              balances vary across states, reflecting variations in program decisions
              and economic conditions.

              The gross federal tax rate is 6.2 percent on the first $7,000 paid in
              wages annually to each employee. If a state meets certain federal
              requirements and has no delinquent federal loans, however, its
              employers are eligible for up to a 5.4 percent credit, making the net fed-
              eral tax rate 0.8 percent. In order for employers to receive the maximum
              federal tax credit of 5.4 percent, states must establish a taxable wage
              base for state UI taxes at least equal to the federal taxable wage base-
              currently $7,000. All states have done this, and 36 states have adopted
              wage bases above the federally mandated base, ranging from $7.100 in
              Connecticut to $20,900 in Alaska.

              Currently, the net federal tax rate of 0.8 percent is made up of a perma-
              nent tax rate of 0.6 percent and a temporary surtax of 0.2 percent The
              surtax was added in 1976 to help the system repay loans from the fed-
              eral general fund. The surtax was extended in 1987 and is due to expire
              at the end of 1990.

              The UI program was supposed to operate on a forward-funding basis:
              that is, tax rates and benefit amounts were set so that the system accu-
              mulated reserves during periods of rising economic activity m ortfcr to
              have sufficient reserves to cover benefit payments during periods of


              Page 8                          GAO/HRLh90124   Unemployment   Insurance   Tour   Funds
contents


Letter                                                                                                  1

Appendix I                                                                                              8
Detailed Background
Appendix II                                                                                            12
Results of GAO          Current UI System Reserves Are Inadequate
                        Effect of a Taxable Wage Base Increase
                                                                                                       12
                                                                                                       13
Analysis                Effect of Increased Taxable Wage Base and Revised                              1.5
                             Extended Benefits

Appendix III                                                                                           17
Simulation Results
Appendix IV                                                                                            18
Economic
Assumptions Used in
RecessionSimulation
Appendix V                                                                                             19
Major Contributors to
This Report
Related GAO Products                                                                                   20

Tables                  Table 1: Effects of a Severe Recession Under Three Policy                        4
                            Conditions (Fiscal Years 1991-96)
                        Table I: Financial Status of UI Accounts (1970-89)                             10
                        Table II. 1: Effects of Severe Recession Under Current                         13
                             Legislation (Fiscal Years 1991 Through 1995)
                        Table 11.2:Effects of Severe Recession Under Current and                        15
                             Proposed Legislation (Fiscal Years 1991 Through
                             1995)
                        Table 11.3:Effect of Increased Taxable Wage Base                                1.’
                             (1978-83)
                        Table III. 1: Current Funding Structure                                         1;
                        Table 111.2:Increased Taxable Wage Base                                         1;


                        Page 6                       GAO/HltB~lZ4   Unemployment   Insurance   Trust Funds
                                         5239714




Table 1: Effects ot a Severe Recerrion
Under Three Policy Conditions (Fiscal    Dollars m bllhons
Years 1991-95)
                                                                                                              Increased
                                                                                                          wage base and
                                                                                                Increased      extended
                                                             -                   Current law   wage base        benefits
                                         State borrowmg                                $174         $14 3          $163
                                         General fund advances to loan account          $6 6         $44            $5 8
                                         State loan balances, end of 1995              $107          $6 5           $7 4
                                         Net state UI balances. end of 1995            $16.5        $29 1          $23 6
                                         Insolvent states                                 17           16             1R



                                         The detailed results of our analysis are contained in appendix II. In
                                         addition, appendix III provides details on the results of each of the simu-
                                         lations for the three policy conditions. Information on the economic
                                         assumptions used in Labor’s model are contained in appendix IV.


                                         Although state trust fund accounts are in their best financial condition
Conclusions                              since the years before the 1973 recession, the reserves in both the fed-
                                         eral and state accounts are not adequate to handle a severe recession in
                                         the near future. Such a recession, starting in 1991, would result in
                                         another round of state borrowing, accompanied by advances from the
                                         general fund. Recent experience indicates that in order to repay loans,
                                         states raise taxes and cut benefits while unemployment is still high.
                                         Such actions lessen the effectiveness of the UI program in achieving its
                                         principal purposes of providing (1) income maintenance to the unem-
                                         ployed and (2) a countercyclical stimulus to the economy. These actions
                                         could be reduced if states maintained adequate balances in their trust
                                         funds.

                                         The proposed increase in the taxable wage base is a means of moving in
                                         the direction of restoring the forward-funding basis of the program. The
                                         increased wage base would (1) improve federal trust fund reserves, (2)
                                         reduce the amount of general fund advances needed should a major
                                         recession begin anytime soon, (3) improve reserves in some states,
                                         thereby reducing the need for them to borrowand (4) provide resources
                                         for a larger Extended Benefits Program. However, if states behave as in
                                         the 1980s they will reduce tax rates as the wage base is increased. To
                                         the extent this occurs, state trust fund reserves may continue to remain
                                         inadequate.
                   5239714




                   of their purchasing power. The program is designed to operate on a for-
                   ward-funding basis, under which the system is supposed to accumulate
                   sufficient reserves during periods of economic growth to pay benefits
                   during periods of economic decline. In recent years, however. many
                   states have not accumulated reserves sufficient to cover benefits during
                   a recession: !nstead, they have relied on advances from the federal 1.1
                   loan accoun ) sustain their programs during economic
                   downturns.     ‘he drop in accumulated reserves has been caused, in
                   part, by high unemployment during four recessions in the last two
                   decades, additional expenditures for the continuation of benefits
                   under the Extended Benefits Program, and increases in benefits
                   without offsetting increases in revenues.4

                   In the past, the states have received substantial loans from the federal
                   UI loan account. This account has needed general fund advances from
                   time to time because of insufficient balances. Since the early 197Os, the
                   states have borrowed about $29.6 billion to pay benefits. H.R. 3896 is
                   aimed, in part, at restoring the forward-funding basis of the UI program
                   by providing the means for the federal and state accounts to accumulate
                   reserves sufficient to cover a recession. The bill would (1) increase the
                   taxable wage base from $7,000 to $10,000 over 3 years and then index
                   this base to the growth in average annual covered wages and (2) revise
                   the Extended Benefits Program by making it easier for states with long-
                   term, high unemployment to qualify for the program. Additional back-
                   ground on the UI program is contained in appendix I.


                   The UI system has built considerable reserves during the past 7 years of
Results in Brief   economic expansion-$&       1 billion in the federal accounts and $36.2 bil-
                   lion in the state trust funds, as of January 1990. Nevertheless, the cur-
                   rent fiiancial condition of the WIsystem appears to be inadequate to
                   handle a severe recession. According to Labor’s model, under current
                   law a severe recession in 1991 would result in 22 states having to
                   borrow an estimated $17.4 billion between 1991 and 1995 to sustain
                   their programs. During or immediately following the recession period,
                    17 of these states would become insolvent-that       is, their trust funds
                   would have negative balances at the end of a year. Fifteen states would

                   o The federal UI account9 include three accounts-the    loan account, the extended benefl~s rl( ~r~mt,
                   and the administration account.
                    4For a detailed discussion of the madequacy of UI trust fund reserves and the factors thal INI to lb
                    decline in the 1970s. see Unemployment Insurance: Trust Fund Reserves Inadequate
                    (GAO/HRD-88-65, Sept.-ZKlIW).
l



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