Portfolio

Abstract
By undertaking secondary data analysis, this research paper underscores and explores the
problem of Underfunding in Unemployment Insurance. Unemployment Insurance (UI) is
underfunded due to outdated policies and a flawed financial structure, leaving it ill-equipped
to support today’s workforce. Strict eligibility requirements in many states exclude a
significant portion of unemployed workers, while those who qualify often receive benefits
too low to cover basic living expenses. Additionally, the system’s financing model imposes a
tax burden on job creation, undermining efforts to stimulate employment. These challenges
highlight the need for further study to reform UI, ensuring it can act as a reliable safety net
during economic downturns and better serve both workers and the broader economy.

Introduction
Workers deserve economic security between jobs. Yet exclusionary and under-resourced
unemployment insurance systems leave job seekers struggling to get by (NELP, 2022).
Unemployment insurance is almost universally recognized as one of the government’s best
tools for fighting recessions, as well as an important source of relief for working-class
families suffering temporary hardship. Unfortunately, as commentators and Congress have
recognized, the U.S. system of financing its unemployment insurance program is seriously
dysfunctional. Reform proposals, however, do not fully diagnose the causes of current
failures. In particular, other commentators neglect the role of fiscal myopia in state officials’
failures to save for future UI needs (Galle, 2019).

How does a government program that is supposed to be the major lifeline for unemployed
workers in times of macroeconomic catastrophe find itself operating on decades-old
computer systems, understaffed, and ill-prepared to serve its basic function? This state of
affairs is neither a coincidence nor a surprise. It is the result of a conscious choice by state
and federal policymakers not to provide adequate levels of resources for the program’s
operation (Gould-Werth, 2020).

New Yorkers right now are concerned about the state of New York’s unemployment
insurance (UI) system. In recent weeks, press coverage, political rhetoric, and an audit by
New York State Comptroller Thomas DiNapoli have assailed the system, sowing mistrust in
one of our most vital social systems (DOL, 2022). An unprecedented influx of unemployment
claims and brand-new federal pandemic programs, in addition to limited staffing, new remote
work challenges, chronic federal underfunding, and other factors, placed a heavy burden on
the system. These challenges paved the way for delayed payments, operational breakdowns,
and fraud – all of which were identified by the Department and later addressed in the
Comptroller’s audit (DOL, 2022).

Unemployment insurance is one of the largest social insurance programs in the United States,
with each state running its own UI program to pay benefits to people laid off from their jobs.
In most states, UI replaces about half of a worker’s earnings up to a weekly benefit maximum
($443 in the median state) for a maximum of 26 weeks (6 months) (Duggan et al., 2020).
Unemployment compensation is a core institution of social insurance. As one of the largest
social insurance programs in the country, Americans file over 1 million new claims each
month (Guo et al., 2020). The unemployment insurance (UI) system is a partnership between
the federal government and state governments that provides a temporary weekly benefit to
qualified workers who lose their job and are seeking work. The amount of that benefit is
based in part on a worker’s past earnings (CBO, 2012). While providing a needed cushion to
workers, UI leaves policymakers with a difficult balancing act. As benefits become more
generous, many recipients reduce their efforts to find and maintain jobs, reducing total
income and burdening other workers (Johnston & Mas, 2018). But if benefits become
stingier, the cushion provides less support leaving some unemployed vulnerable to falling
behind on their bills or lose their housing (Ganong & Noel, 2019). Finally, because
employers pay the entire payroll tax, they have put pressure on state governments to not raise
the tax rates, contributing to the underfunding. In the case of UI, allowing state
administration and a hybrid federal-state partnership for financing has not produced any clear
gains. In contrast, the patchwork of rules and pressure
to cut benefits for budgetary reasons has produced a system that is inadequate and arbitrary
(Dube, 2021).

Background and Context

The Unemployment Insurance (UI) program was established in 1935 under Titles III and IX
of the Social Security Act. Employers began paying taxes into state accounts in the
Unemployment Trust Fund in 1936, but to allow the Fund to accumulate reserves, payment of
UI benefits did not begin until 1938. Administratively, the UI system was established as a
federal-state program. The Social Security Act sets conformity requirements for the states’
participation in the program, but the federal government frequently has had difficulty
enforcing these requirements with the mechanisms available to it (Wandner, 2023).

Unemployment benefits are not paid out from state budgets, but rather a designated trust fund
into which employer contributions are paid. State UI trusts have varying reserves, depending
on the size and prevalence of claims as well as their ability to recoup costs from employers.
As a rule of thumb, if a state has in trust a reserve ratio greater than its average
recession-level benefit costs, the U.S. Department of Labor considers the state program to
have “minimum adequate funding” (Guo et al., 2020). States may exploit this different
treatment of interest between the state UI Trust Fund account at the U.S. Treasury and the
state reserve fund to gain flexibility in using the interest income generated by the reserve
fund. They may divert this interest income into a related state account (hereafter termed a
derivative account) (Vroman et al., 2017).

The unemployment insurance system is the country’s only automatic income support program
for individuals who have lost work. It kicks in automatically when job losses start—without
the delays and political and policy wrangling about if, when, or how to respond. The program
serves as a key stabilizer during economic downturns by buttressing consumer spending,
demand, and sentiment—preventing people’s fears of job loss from constricting private
demand for spending on goods and services faster than the initial job losses (EPI, 2021).
Faced with massive job losses, the program would have proven an insufficient automatic
stabilizer because of its huge gaps in coverage (EPI, 2021).

The Great Recession exposed in dramatic fashion important structural weaknesses in the
design of the American UI system. Even as the availability of UI helped to prop up the
economy during the recent recession and to shield individual families from the hardships the
recession brought, key aspects of the program were also hurting the economy, and leaving
without any benefits households that had long been effectively contributing UI premiums. UI

betrayed its promises (Galle, 2019). UI failed in two distinct ways. One failure, relatively
well-known to the handful of scholars who closely study social insurance programs, was in
the remarkably small share of unemployed households who actually received benefits. A
second, less familiar, story is that the system for paying for UI financing had unexpectedly
perverse effects on the labor market. In effect, while states and the federal government were
struggling to incentivize employers to hire more, the UI system was imposing an extra tax
burden on each new job (Galle, 2019).

The surge of new claims for unemployment insurance (UI) following the COVID-19
pandemic is rapidly depleting states’ UI trust fund reserves. By early July, the trust funds of
three of the four largest states (California, New York, and Texas) were already insolvent,
requiring them to borrow to cover benefits (Lachowska et al., 2020). The COVID-19 crisis
has put unemployment insurance at the center stage of American politics and economic
policy. It has provided a lifeline for tens of millions of workers who have lost their jobs since
the pandemic’s onset six months ago, while at the same time exposing the system’s
vulnerabilities. Given the complexity of UI financing and the scarcity of empirical evidence
on which to rely, this is an important area for additional work and exploration. Unless
policymakers take steps to reform how the state’s unemployment insurance trust funds are
financed, tax hikes will hurt labor market recoveries across the country — and with them, the
American worker (Duggan et al., 2020).

According to the Government Accountability Office, an estimated $100-$135 billion was lost
to UI fraud during the pandemic alone. In response, the House passed the bipartisan
Protecting Taxpayers and Victims of Unemployment Fraud Act (H.R. 1163), which includes
steps to strengthen program integrity, recover lost funds, and prevent future fraud. The federal
government collects unemployment insurance taxes, called Federal Unemployment Tax Act
(FUTA) taxes, from employers in each state, but often fails to return most of it to states to
help administer UI programs. In Fiscal Year 2022, states received $3.7 billion less in
administrative funding than employers collectively paid in FUTA taxes. The administrative
financing mechanism for UI has prevented states from investing in long-term technology
solutions, as one witness testified to Work and Welfare Subcommittee Chairman Darin
LaHood (IL-16) (Ways and Means, 2024).

The thinning tax base is a leading cause of low UI reserves. States choose how much of a
worker’s earnings are exposed to UI taxation, but the federal government can “update” the
minimum requirement to keep pace with inflation and the rise in average earnings. The
current federal requirement of $7,000 has —remarkably — not been updated since 1982,
eroding the tax base unless states have legislated increases or proactively linked their taxable
UI earnings base to inflation or wage growth (Duggan et al., 2020).

Another important consequence of a small tax base is that UI taxes become much more
regressive. This can reduce the employment opportunities for part-time workers or those with
low earnings since firms essentially pay an equal tax for each worker (Guo & Johnston, 2020)
In some senses, the explanation for how UI has come to this pass is depressingly familiar.
UI’s structural problems closely resemble the institutional and political problems that have
bedeviled U.S. infrastructure spending, as well as those that discourage state and local
governments from establishing “rainy day funds” or adequately contributing to their
employee pension funds (Galle, 2019).

A few unique features of UI further contribute to its malaise. Federalism is the root of most of
UI’s failings. The decision to finance and administer UI mostly at the state level was based in
politics, not policy. As other commentators recognize, modern theories of fiscal federalism
predict that states will systematically underinvest in UI, and there is direct historical evidence
to support those predictions (Galle, 2019).

Problem Identified in UI
This research paper identifies underfunding as a problem in the UI program. This section
goes on to discuss three major reasons behind the underfunding.

The federal UI taxable wage base that is the basis for the financing of UI program
administration, the Employment Service, the federal share of Extended Benefits, and the
federal loans to states when their state UI trust fund accounts become insolvent. It also sets a
minimum wage base for the state tax systems. The tax base together with UI tax rates
determine the capacity of the UI program to finance an adequate level of benefits and
services (Wandner, 2023). The Social Security taxable wage base was increased by Congress
in 1951 and was subsequently increased through the 1950s and 1960s. Starting in the 1970s,
the Social Security taxable wage base became indexed and has increased steadily until it

reached $160,200 in 2023 (Whitman & Shoffner, 2011). By contrast, the federal UI taxable
wage base only has been increased three times—in 1972, 1978, and 1983 and has remained at
$7000 for 40 years. Thus, the UI taxable wage base has declined to less than 30 percent of
total wages. Because of inadequate forward funding, many states have found that their state
trust fund accounts—in which the positive balance of their state UI reserves are held in the
U.S. Treasury—are exhausted during recessions. State UI programs continue paying benefits
because they can borrow from the U.S. Treasury–maintained Unemployment. Trust Fund. To
repay loans from the U.S. Treasury, states must rebuild their UI balances in their state UI
accounts. Many states opt for a heavy dose of benefit cuts rather than raising tax rates or their
state taxable wage base (Wandner, 2023).

A DOL report in 2020 found that around half of the states’ UI trust funds
were underfunded (DOL, 2020). In addition to the delays in processing benefits, weaknesses
of some of the state UI systems drew the attention of organized criminal enterprises, which
engaged in identity theft and other forms of fraud to steal funds. Well-publicized cases of
fraud led to measures that slowed the delivery of benefits to legitimate applicants in some
states (Cohen 2020; Holzhauer 2020).

Since the 1980s, recessions have been more related to financial markets than inventory
cycles, and they have been more severe than state unemployment trust funds were designed
to handle. The disruptions are greater, causing more permanent job losses than cyclical
temporary layoffs. The average duration of unemployment is trending upward, and it takes
longer to return to previous peak employment levels (Freeman, 2013).

As discussed, the UI program was scarcely used in the United States in the period through the
end of World War II. UI benefits then increased until the 1970s when they started to decline.
While UI benefits have continued to gradually erode over time, there have been two
inflection points that marked a change in state policy and legislation, in 1975 and again in

2010. Both of those inflection points were in response to two severe recessions, 1973–1975
      and 2007–2009. In both cases, many states found their state reserves in the Unemployment
      Trust Fund were inadequate and responded not only by increasing taxes but also by cutting
      benefits (Wandner, 2023).

Indeed, the root cause of many of the administrative problems during the pandemic, which
persist today, is the lack of consistent and sustainable administrative funding for state
agencies. Federal funding to states for UI administration has generally remained flat or
declined for the better part of the last four decades as suggested by the DOL UI Budget,
leaving these agencies woefully understaffed and resourced heading into the pandemic
(Gwym & Gerry, 2023).

While Congress increased administrative funding last year, that was insufficient to remedy
years of disinvestment and underfunding of the system at both the state and federal levels.
States need consistent, sustainable funding so they can invest in long-term projects and staff
to be ready for the next recession (Gwym & Gerry, 2023).

We can draw two conclusions. First, states that pay low levels of benefits also make it
difficult for unemployed workers to access their UI systems, as can be seen in the analysis of
the North Carolina and Florida programs in the next section. Second, states that make access
to the UI program difficult and pay low levels and durations of benefits tend to achieve what
at first blush appears to be sound UI financing (e.g., reaching state UI trust fund high-cost
multiples of 1.0 or more) by constricting benefits (e.g., having low maximum weekly benefits
and low potential duration), rather than ensuring that they have sufficient revenue to pay
adequate benefits (see Chapter 10). The implication for UI reform is that legislating benefit
standards to address the benefit replacement rate, benefit maximum, and benefit duration is
necessary but insufficient (Wandner, 2023).

Unemployment benefits provide critical support to jobless workers, their families and
communities, and the U.S. economy. Yet today, the UI system is alarmingly unprepared for
the next recession. Permanent reform is needed to ensure the UI system works for all workers
at all times, but if a near-term economic downturn occurs, Congress must be prepared to
enact emergency measures to address the most significant deficiencies in the current system
(Gwym & Gerry, 2023).

With policy as it stands, we will also repeat problems with benefit extensions at the crisis’s
middle and the depletion of trust funds and erosion of benefit levels at the crisis’s end. And,
as was the case in the Great Recession, in the first months of the coronavirus crisis,

policymakers today refuse to remedy the issues at the heart of these administrative failures.
But it’s not too late (Gould-Werth, 2020).

Western European governments are amazed at how weak the U.S. system is and has been for
decades (Wandner, 2023). Compared to the 21 members of the OECD—Western European
or English-speaking countries plus Japan and Korea—the United States is an outlier
concerning all three aspects of the program: UI administration, financing, and benefit
payments (Vroman 2012; Vroman et al., 2017).
I. National program. All other countries administer a national UI program with one set
of laws and administrative procedures that operate throughout their countries.
II. Experience rating. No other country applies experience ratings to individual firms to
finance their UI program.
III. Low taxable wage base. Compared to other countries that finance their programs with
payroll taxes, the United States utilizes an extremely low taxable wage base. For the
decade 2000–2009, the U.S. taxable wage base averaged 28 percent of total wages,
whereas the 19 countries that used payroll taxes averaged between 72 and 100
percent, with 8 countries taxing total wages.
IV. Employee contributions. Employees pay UI payroll taxes in almost all OECD UI
programs, and typically those taxes account or a substantial percentage of total UI
program revenue. The financing arrangements in these programs are highly varied,
but most rely heavily on payroll taxes. Australia and New Zealand were outliers,
financing UI out of general revenue.
V. Employee-employer share of contributions. Out of the 15 countries for which data
were available, employers and employees shared the burden equally in 5 countries. In
8 other countries, the employee share ranged from 22 percent to 42 percent of the
combined tax rate. The median employee share for the 15 countries in 2012 was 35
percent.
VI. Recipiency rates. Most OECD countries have higher recipiency rates than the United
States (OECD, n.d).
VII. Short-time compensation/work sharing. Unlike the United States, which has a
state option STC program, at least 19 of the 34 OECD countries have national
short-term compensation programs (Cahuc 2019).5 Many increase the replacement

rate and duration of short-time compensation program benefits during periods of high
unemployment (Wandner 2010).
We should be more generous, not less, with our unemployment benefits. The United States
spends less than nearly every other country on its unemployment program. The result is the
underfunded and inadequate system that let down so many unemployed this past year. We
must seriously consider adopting a federal unemployment system like that proposed in June
by labor experts from seven organizations to expand unemployment insurance eligibility, tie
benefit duration to federal and state unemployment rates, and make the replacement rates
more generous for those at the bottom of the wage pool (Damaske, 2021).

In short, these programs generally are financed by payroll taxes on both employers and
employees, with a substantial employee contribution. The tax rates are imposed on high
taxable wage bases. Most of these countries try to avoid layoffs, if possible, by using
generous short-time compensation programs during deep recessions (Wandner, 2023). Until
we realize that a lack of generosity prevents workers from searching for work, our
unemployment system will continue to fail those who need it the most (Damaske, 2021).

Policy Recommendations/ Solutions
Policy proposal 1: Fund regular unemployment benefits and the full cost of extended benefits
with federal financing
No solution short of federal financing will fully overcome these problems; if states can
compete with one another to lower taxes, they will. If their revenue is lower, they will find
new ways to reduce recipiency rates. Following the Great Recession, for example, when
federal law temporarily constrained states from reducing benefit amounts, they cut the
duration of benefits (CRS 2019; Smith, Wilson, and Bivens 2014). Some states also erected
new administrative barriers (Wentworth 2017).

Increasing the taxable wage base
Currently, states and the federal government finance UI almost exclusively through taxes on
employers. The total tax an employer owes is based on the product of its tax rate and the
taxable wage base, the portion of each employee’s salary that is considered when calculating
the tax owed. For the current federal UI tax—the Federal Unemployment Tax Act (FUTA)
tax—the federal government taxes only the first $7,000 of each employee’s wages. State

wage bases cannot be lower than the federal wage base; they currently range from $7,000 to
about $53,000, with most of them less than $15,000 (U.S. DOL-ETA 2020c). The taxable
maximums for UI wage bases are far lower than the taxable maximum wage bases for other
programs. For example, the wage cap for the Social Security portion of the Federal Insurance
Contributions Act (FICA) for 2021 was $142,800. The UI federal wage base has failed to
keep up with inflation; it was $3,000 in 1939, or more than $55,000 in 2021 dollars, almost
eight times its current value of $7,000 (Gould-Werth, 2020a).

PROPOSAL 2: MAKE UI A FEDERALLY FINANCED AND ADMINISTERED
PROGRAM
Under my proposal, UI will be made a fully federally administered program, like Social
Security. Part of the costs of the program—reflecting regular benefits paid during normal
times—would be paid using a federal payroll tax, while the balance would be paid using
general federal revenue. I recommend that the payroll tax be levied on both employers and
employees, similar to Social Security. Since the current system is based only on employer
taxes, there will be some added costs for workers. However, note that even when employers
nominally pay a payroll tax, it is partly paid for by workers through lower wages. In other
words, if all of the added taxes needed to pay for the proposed benefits were nominally on
employers, some of those taxes would be passed through to workers as lower wages. At the
same time, the pass-through of employer taxes to wages is likely to be incomplete, which is
why employers often lobby against increases in the tax rates. Importantly, as O’Leary and
Wandner (2018) argue, moving away from an employer-only system could reduce some
employer opposition to changes in benefit generosity (Farrell et al., 2020; Dube, 2021).

Other solutions

Shoring up the trust funds
The pandemic has shed light on the vulnerability of UI financing. Better maintenance of UI
trust funds is vital to prepare states for the next economic downturn and improve prospects
for future recoveries. There is a large and growing gap in UI tax costs across jurisdictions.
States like California and Florida have a low maximum tax rate and an annual tax base of
around $7,000 — the lowest allowed by federal law — resulting in maximum potential UI
taxes of about $400 per worker. In contrast, states like Washington and Oregon maintain large

tax bases ($52,700 and $42,100, respectively) resulting in potential UI taxes of more than
$2,000 per worker. In good times, states store revenues from UI taxes in a trust fund and that
fund is drawn down in the depth of recessions. In recent years, however, state trust funds
have been low even in good times — a function of benefits that are more generous than their
financing (von Wachter, 2016). The Department of Labor’s 2020 Solvency Report shows that
despite a 10-year economic expansion, 21 state UI trust funds were below the minimum
recommended reserve, just before the pandemic (DOL, 2020). These deficits may contribute
to lethargic recoveries. When trust funds are low, states must steeply raise rates to recover
their costs and pay benefits. The timing of these increases could not be worse. Weak trust
funds also undermine experience ratings. When a state trust fund is in debt to the federal
government, federal UI taxes rise on all firms in that state until the federal loan is repaid,
regardless of the firm’s layoffs. (Duggan et al., 2020)

Need for an effective State administration
The state administration of this program has created a patchwork of rules that have little
benefits but many costs. At a basic level, a state-based system prevents insurance across
states. For example, if a particular state is hit harder by a downturn, it will be in a deeper hole
when it comes to rebuilding its trust fund and will therefore need to raise payroll taxes by a
greater amount. Moreover, a state-based system does not allow easy adaptation to new
circumstances, such as changing benefit levels—as demonstrated during the current crisis
(Dube, 2021). As demonstrated during the current crisis, there was substantial variation
in the timing by state; this variation was costly in terms of consumption loss.

Unemployment insurance is almost universally recognized as one of a government’s best
tools for fighting recessions, as well as an important source of relief for working-class
families suffering temporary hardship. Unfortunately, as commentators and Congress have
recognized, the U.S. system of financing its unemployment insurance program is seriously
dysfunctional. Reform proposals, however, do not fully diagnose the causes of current
failures. In particular, other commentators neglect the role of fiscal myopia in state officials’
failures to save for future UI needs. For instance, reformers mostly propose offering rewards
or penalties that will take effect far in the future. These incentives have only small effects on
myopic officials (Galle, 2018).

Conclusion

Based on the above-mentioned arguments, without significant policy changes and a
commitment to long-term funding solutions, the U.S. UI Program will continue to fall short
in its mission to support unemployed individuals and stabilize the economy during
downturns. The time for reform is now; proactive measures must be taken to prepare for
future economic challenges and ensure that all workers have access to essential benefits when
they need the most.

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