The Unemployment Trust Fund (UTF): State Insolvency and Federal Loans to States
Released: 2019-01-30T00:00:00

Unemployment Compensation, Unemployment Taxes, and a State's Obligation to Pay Benefits

Unemployment Compensation (UC) is a joint federal-state program financed by federal payroll taxes under the Federal Unemployment Tax Act (FUTA) and by state payroll taxes under State Unemployment Tax Acts (SUTA). These revenues are deposited into the appropriate account within the federal Unemployment Trust Fund (UTF).

Originally, the intent of the UC program, among other goals, was to help counter economic fluctuations such as recessions. This intent is reflected in the current UC program's funding and benefit structure. When the economy grows, UC program revenue rises through increased tax revenues. At the same time, UC program spending falls because fewer workers are unemployed. The effect of collecting more taxes while decreasing spending on benefits dampens demand in the economy. It also creates a surplus of funds, or a reserve fund , for the UC program to draw upon during a recession. These reserve balances are credited in the state's account within the UTF. During an economic slowdown or recession, UC tax revenue falls and UC program spending rises as more workers lose their jobs and receive UC benefits. The increased amount of UC payments to unemployed workers dampens the economic effect of lost earnings by injecting additional funds into the economy.

State and Federal Unemployment Taxes

State Unemployment Taxes

States levy their own payroll taxes (SUTA) on employers to fund regular UC benefits and the state share (50%) of the Extended Benefit (EB) program. Federal laws and regulations provide broad guidelines for these state taxes. Each state deposits its SUTA revenue into its account within the UTF.

SUTA revenue finances UC benefits. Generally, when economic activity is robust and increasing, SUTA revenue is greater than a state's UC expenditures. As a result, the state's reserves within the UTF grow. This trend is reversed during economic recessions and during the early economic recovery period, when the state's reserves are drawn down and new SUTA revenue does not always make up the shortfall.

If the recession is deep enough and if SUTA revenue is inadequate for long periods of time, states may have insufficient funds to pay for UC benefits. Federal law, which requires states to pay these benefits, provides a loan mechanism within the UTF framework that an insolvent state may opt to use to meet its UC benefit payment obligations. States must pay back these loans. If the loans are not paid back quickly (depending on the timing of the beginning of the loan period), states may face interest charges and the states' employers may face increased net FUTA rates until the loans are repaid.

In the years immediately following the most recent recession, many states had insufficient SUTA revenue and UTF account balances to pay UC benefits.

Federal Unemployment Taxes

All FUTA revenue is deposited into the Employment Security Administration Account (ESAA) within the UTF. Federal unemployment taxes pay for the federal share of EB (50%) and for administrative grants to the states. Additionally, through the federal loan account within the UTF, FUTA funds may be loaned to insolvent states to assist the payment of the states' UC obligations.

Net FUTA Rate Is 0.6%

FUTA imposes a 6.0% gross federal unemployment tax rate on the first $7,000 paid annually by employers to each employee. Employers in states with programs approved by the U.S. Labor Secretary and with no outstanding federal loans may credit up to 5.4 percentage points of state unemployment taxes paid against the 6.0% tax rate, making the minimum net federal unemployment tax rate 0.6%.

Because most employees earn more than the $7,000 taxable wage ceiling in a calendar year, the FUTA tax typically is $42 per worker per year ($7,000 × 0.6%), or just over 2 cents per hour for a full-time, year-round worker.

States Required to Pay UC Benefits

States have a great deal of autonomy in how they establish and run their unemployment insurance programs. However, the framework established by federal laws is clear and requires states to promptly pay the UC benefits as provided under state law.

In budgetary terms, UC benefits are an entitlement (although the program is financed by a dedicated tax imposed on employers and not by general revenue). Thus, even if a recession hits a given state and, as a result, that state's trust fund account is depleted, the state remains legally required to continue paying benefits. To do so, the state might borrow money either from the dedicated loan account within the UTF or from outside sources.

If the state chooses to borrow funds from the UTF, not only will the state be required to continue paying benefits, it also will be required to repay the funds (plus any interest due) it has borrowed from the federal loan account within a few years. Such states may need to raise taxes on their employers or reduce UC benefit levels, actions that dampen economic growth, job creation, and consumer demand. In short, states have strong incentives to keep adequate funds in their trust fund accounts.

If the state borrows from sources outside the UTF, the state would not be subject to the loan restrictions described below. Instead, the state would be subject to the terms within that outside loan agreement, which might offer a different (more favorable) interest rate or repayment schedule but may include fees to establish the loan.

Funds Available for Loans to States Within the UTF

The Federal Unemployment Account (FUA) is the federal loan account within the UTF. The FUA is primarily funded from the statutory transfer of excess revenue from the Extended Unemployment Compensation Account (EUCA) being deposited into the FUA.

If needed, the FUA may borrow funds from other federal accounts within the UTF or from the general fund of the U.S. Treasury. From FY2009 to FY2015, the FUA had to borrow funds from the U.S. Treasury to finance loans to the state accounts.

1. Revenue from additional FUTA taxes paid by employers when a reduced credit against federal unemployment taxes exists because the state has an outstanding unpaid loan from FUA is deposited into the FUA. (See the discussion below on " Federal Tax Increases on Outstanding Loans Through Credit Reductions " for a more detailed explanation of these additional taxes.) 2. Federal law allows the FUA to borrow available funds from the other federal (EUCA and ESAA) accounts within the UTF. 3. Federal law also authorizes appropriations as loans from the general fund of the U.S. Treasury if balances in the federal accounts are insufficient to cover their expenditures. (For example, if the states' borrowing needs exceed the available FUA balance.) Such appropriations require discretionary action by Congress and the President.

Mechanism for Receiving a Loan from the UTF

Once a state recognizes that it does not have sufficient funds to pay UC benefits, the mechanism for receiving a loan from the UTF is straightforward. The state's governor (or the governor's designee) must submit a letter requesting that the U.S. Labor Secretary advance funds to the state account within the UTF. Once the loan is approved by the U.S. Labor Secretary, the funds are placed into the state account in monthly increments.

Loan Repayment

States with outstanding loans from the UTF must repay them fully by the November 10 following the second consecutive January 1 on which the state has an outstanding loan. If the outstanding loan is not repaid by that time, the state will face an effective federal tax increase. Thus, a state may have approximately 22 months (if borrowing began on January 1) to 34 months (if borrowing began on January 2) to repay the loan without a federal tax increase, depending on when it obtained the outstanding loan.

As of January 29, 2019, approximately $68.3 million in federal UTF loans to the states were outstanding. A current list of states with outstanding loans may be found at the Department of Labor's (DOL's) website, https://oui.doleta.gov/unemploy/budget.asp .

Federal Tax Increases on Outstanding Loans Through Credit Reductions

If the state does not repay a loan by November 10 of the second year, the state becomes subject to a reduction in the amount of state unemployment tax credit applied against the federal unemployment tax beginning with the preceding January 1 until the state repays the loan fully. Depending on the duration of the loan and certain other measures, one or more of three different credit reductions may be required. These reductions are fully catalogued in Table 1 . At the height of the period following the most recent recession (2011), 20 states and the Virgin Islands faced increased FUTA rates because of outstanding UTF loans.

Basic Credit Reduction

The credit reduction is initially a 0.3 percentage point reduction for the year beginning with the calendar year in which the second consecutive January 1 passes during which the loan is outstanding and increases by a 0.3 percentage point reduction for each year there is an outstanding loan. For example, in the first year, the credit reduction results in the net federal tax rate increasing from 0.6% to 0.9%—an additional $21 for each employee; in the second year, it would increase to 1.2%—a cumulative additional $42 for each employee.

Additional Credit Reductions: 2.7 Add-on and Benefit-Cost Ratio Add-on

Two potential other credit reductions exist (in addition to the cumulative 0.3 percentage point increases) during the ensuing calendar years in which a state has an outstanding loan:

1. Beginning in the third year, the 2.7 add-on uses a statutory formula that takes into consideration the average annual wages and average employment contribution rate. 2. Beginning in the fifth year, the Benefit-Cost Ratio (BCR) add-on replaces the 2.7 add-on and uses the five-year benefit-cost rate as well as average wages in its calculation.

Table 1 presents these reductions and the subsequent net FUTA tax faced by state employers as a result of these unpaid loans. If any January 1 passes without an outstanding balance, the year count starts over with the next loan. DOL maintains a list of potential reduced credit states at http://workforcesecurity.doleta.gov/unemploy/docs/reduced_credit_states.xlsx .

Avoiding Some or All of the Credit Reduction

Section 272 of P.L. 97-248 allows a delinquent state the option of repaying—on or before November 9—a portion of its outstanding loans each year through transfer of a specified amount from its account in the UTF to the FUA.

If the state complies with all the requirements listed below, the potential credit reduction is avoided (there is no reduction):

The state must repay all loans for the most recent one-year period ending on November 9, plus the potential additional taxes that would have been imposed for the tax year based upon a state tax credit reduction. The state must have sufficient amounts in the state account of the UTF to pay all compensation for the last quarter of that calendar year without receiving a loan. The state also must have altered its state law to increase the net solvency of its account with the UTF.

From 2011 through 2014, South Carolina met these requirements. As a result, employers in South Carolina were not subject to a state tax credit reduction in the calculation of their FUTA taxes. (Generally, employers in South Carolina would have paid more in state unemployment taxes to meet these requirements.)

Avoiding Credit Reduction: Cap

Once a state begins to have a credit reduction, the state may apply to have the reductions capped if the state meets four criteria:

No legislative or other action in 12 months ending September 30 has been taken to decrease the state's unemployment tax effort. (A state cannot actively decrease its expected state unemployment tax revenue from current law.) No legislative or other action has been taken to decrease the net solvency of the state's trust fund account. (For example, the state would not be allowed to actively increase the average UC benefit amount from current law requirements.) Average state unemployment tax rate on total wages must exceed the five-year average benefit-cost rate on total wages. Balance of outstanding loans as of September 30 must not be greater than the balance three years before.

Waiving the BCR Add-on

The BCR add-on may be waived if the Secretary of Labor determines the state did not take legislative or other actions to decrease the net solvency of the state's trust fund account. The 2.7 add-on would then replace the BCR add-on.

Revenue from Credit Reductions Reduces State UTF Loans

The additional federal taxes attributable to the credit reduction are applied against the state's outstanding UTF loan. Thus, although technically employers are paying additional FUTA taxes, the additional tax pays off a state's debt. The state's employers will pay the additional federal taxes resulting from the credit reduction no later than January 31 of the next calendar year.

Interest Charges on Loans

Since April 1, 1982 ( P.L. 97-35 as amended), states have been charged interest on new loans that are not repaid by the end of the fiscal year in which they were obtained. (Before April 1, 1982, states could receive these loans interest free.)

The interest is the same rate as that paid by the federal government on state reserves in the UTF for the quarter ending December 31 of the preceding year but not higher than 10% per annum. The interest rate for calendar year loans is determined by Section 1202(b)(4) of the Social Security Act. The interest rate for a calendar year is the earnings yield on the UTF for the quarter ending December 31 of the previous calendar year. The U.S. Treasury Department calculated the fourth-quarter earnings yield in 2018 to be 2.3081%. Thus, loans made in calendar year 2019 are subject to an interest rate of 2.3081%.

States may not pay the interest directly or indirectly from SUTA revenue or funds in their state account within the UTF. If a state does not repay the interest, or if it pays the interest with funds from SUTA taxes, DOL is required by federal law to refuse to certify that state's program as being in compliance with federal law. Not being in compliance with federal unemployment law would mean that the state would not be eligible to receive administrative grants and employers in that state would not receive the state unemployment tax credit in the calculation of their federal unemployment taxes.

States may borrow funds without interest from the UTF during the year. To receive these interest-free loans, the states must meet five conditions:

1. The states must repay the loans by September 30.

2. For those repaid (by September 30) loans to maintain their interest-free status, there cannot be any loans made to that state in October, November, or December of the calendar year of such an interest-free loan. If loans are made in the last quarter of the calendar year, the "interest-free" loans made in the previous fiscal year will retroactively accrue interest charges.

3. The states must meet funding goals relating to their account in the UTF, established under regulations issued by DOL.

In addition to these first three requirements, the phase-in of two new requirements began in 2014. The full effect of the requirements began in 2019.

4. States must have had at least one year in the past five calendar years before the year in which advances are taken in which the Average High Cost Multiple (AHCM) was greater than or equal to 1.0.

5. Additionally, states must meet two criteria for maintenance-of-tax effort in every year from the most recent year the AHCM was at least 1.0 and the year in which loans are taken.

a. The average state unemployment tax rate (total state unemployment tax amount collected over total taxable wages) was at least 80% of the prior year's rate.

b. The average state unemployment tax rate was at least 75% of the average benefit-cost ratio over the preceding five calendar years, where the benefit-cost ratio for a year is defined as the amount of benefits and interest paid in the year divided by the total covered wages paid in the year.

Status of Outstanding Loans, Accrued Interest Owed, and State Tax Credit Reductions

Table 2 lists outstanding state loans. (At this time, only the U.S. Virgin Islands has an outstanding loan.) The table also includes information on accrued interest payments for FY2019. The third column provides information on whether the state was subject to a credit reduction for tax year 2018. The last column provides the net FUTA tax faced by employers in each state that had an outstanding loan.