This chapter discusses the financing of UI benefit and administrative taxes. Generally, a federal tax finances the administration costs and some benefit payments. State payroll taxes finance the costs of most benefits. Federal law also considerably influences the financing provisions of state law.

AMOUNT OF TAX-Under the provisions of the Federal Unemployment Tax Act (FUTA), a federal tax is levied on covered employers at a current rate of 6.2% on wages up to $7,000 a year paid to a worker. The law, however, provides a credit against federal tax liability of up to 5.4% to employers who pay state taxes timely under an approved state UI program. This credit is allowed regardless of the amount of the tax paid to the state by the employer. Accordingly, in states meeting the specified requirements, employers pay an effective federal tax of 0.8%, or a maximum of $56 per covered worker, per year. This 6.2% tax includes a 0.2% surtax scheduled to terminate at the end of 2007. The federal tax is not levied against workers.

Historical Note: Initially, the federal tax was 1.0% (0.1% effective tax) of the total wages of a worker. By 1940, it increased to 3.0% (2.7% effective tax) on wages up to $3,000. Since then, the rate has increased a number of times, occasionally, on a temporary basis. The taxable wage base increased to $4,200 in 1972, $6,000 in 1978, and $7,000 in 1983.

The credit against the federal tax may be reduced if the state has an outstanding advance (commonly called a "loan"). When states lack the funds to pay UI, they may obtain loans from the federal government. To assure that these loans are repaid, federal law provides that when a state has an outstanding loan balance on January 1 for 2 consecutive years, the full amount of the loan must be repaid before November 10 of the second year, or the credit available to employers will be reduced until the loan is repaid. Section 3302(c), FUTA, provides for certain limits on this credit reduction. Except for cash flow loans (loans obtained from January through September and repaid by September 30 of the same calendar year), interest is charged on all loans made on or after April 1, 1982. The rate is the lesser of 10 percent or the rate of interest paid on the state reserve balance in the federal UTF for the last quarter of the preceding calendar year. Interest payments may not be made from the state's unemployment fund.

USE OF FEDERAL REVENUES-The federal tax funds the following costs:

• Federal and state administrative costs for the UI program.
• The federal share of benefits paid under the Federal-State Extended Unemployment Compensation Act of 1970. (This program "triggers on" during periods of high and rising unemployment.)
• The loan fund from which an individual state may obtain advances (or "loans") whenever it lacks funds to pay UI due.
• Labor exchange services under the Wagner-Peyser Act, employment and training services for veterans and disabled veterans under chapter 41 of title 38 of the U.S. code and some labor market information program activities.

THE UNEMPLOYMENT TRUST FUND-The federal UTF in the U.S. Treasury consists of 59 accounts:

• One account for each state. Each state account consists of the contributions and reimbursements collected by the state. Interest earned on these amounts is credited to the state accounts. Money is withdrawn from state accounts for benefits, refunds of contributions erroneously paid, and limited statutory exceptions.
• The employment security administration account. Each year, Congress appropriates from this account the funds necessary for administering the Federal-State UI program, labor exchange services under the Wagner- Peyser Act, employment and training services for veterans and disabled veterans under chapter 41 of title 38 of the U.S. code and some labor market information program activities.
• The extended unemployment Compensation account reimburses the states for the federal share of extended benefits.
• The federal unemployment account provides states with repayable advances for paying benefits.
• The federal employees compensation account finances benefit payments to former federal and military emp1oyees.
• Two accounts related to the Railroad Retirement Board.

All federal payroll taxes are deposited in the employment security administration account. Amounts equal to one-tenth of net monthly collections are automatically transferred to the extended unemployment compensation account.

On September 30thof each year, the net balance in the employment security administration account is determined. If the amount in this account equals 40 percent of the prior year's appropriation by Congress, then an "excess" exists. This excess is transferred to the extended unemployment compensation account and/or the federal unemployment account as provided by the Social Security Act unless both of these accounts exceed their maximum balances. The net balances of the extended unemployment compensation account and the federal unemployment account are also determined on September 30"of each year. The maximum balance in the extended unemployment compensation account is equals 0.5 percent of total wages in covered employment for the preceding calendar year. For the federal unemployment account, the maximum balance equals 0.25 percent (0.5 percent beginning October 1, 200 1) of total wages in covered employment for the calendar year. Excess balances are transferred between these accounts or to the administration account as required by the Social Security Act. If all three accounts are at their statutory limits, then the excess amounts are distributed to the accounts of the states in the UTF in the same proportion that their covered payrolls bear to the aggregate covered payrolls of all states. These are commonly called "Reed Act" distributions.

Technical Note The Social Security Act provides that the maximum balance in the extended unemployment compensation account is the greater of $750 million or 0.5 percent of total wages in covered employment. Due to the growth in covered employment, the $750 million figure is effectively obsolete. A similar provision relating to the federal unemployment account ($550 million) is similarly obsolete.

With the exception of Reed Act moneys, the sums deposited in a state's account are available only for benefit purposes and as previously noted. A state may through an appropriation of its legislature use Reed Act moneys under certain conditions to supplement federal administration grants in financing its UI program and system of public employment offices.

Forty-eight¹ states have amended their UI laws to permit use of these Reed Act moneys for administrative purposes, and most states have appropriated funds for buildings, supplies, and other administrative expenses.

¹ All states except DE, DC, IL, PR and SD.

To enable employers to obtain credit against the federal tax, all states finance the costs of UI benefits by imposing payroll taxes, commonly called "contributions," on employers. In addition, 3 state laws require employee contributions under certain conditions. Federal law requires that nonprofit organizations, state and local governmental entities, and federally recognized Indian tribes be given the option of making "payments in lieu of contributions" (commonly called "reimbursements").

EMPLOYER TAXES-The amount of tax an employer pays depends on the number of its employees, the state's taxable wages, and the contribution rate assigned the employer.

Since employers wish to receive the maximum credit of 5.4 percent against the federal payroll tax, all state laws provide for assignment of a contribution rate of 5.4 percent or higher. In all states, an employer pays a contribution rate based on its "experience." In all states, new and newly-covered employers pay a "new employer rate" until they meet the requirements for experience rating. In some states, additional contributions are required when fund levels drop to specified points or to restore amounts expended for noncharged or ineffectively charged benefits. Noncharged benefits are those charged to a general account rather than an individual employer account. Ineffectively charged benefits include those charged to inactive and terminated accounts and those charged to an employer's experience rating account after the previously charged benefits to the account were sufficient to qualify the employer for the maximum contribution rate. In some states, the state UI agency collects additional taxes imposed on the employer's payroll. Although the revenues from these additional taxes are not deposited in the state's unemployment fund, they sometimes serve UI or employment and training purposes.

In every state an employer who has overpaid contributions is entitled to a refund. These refunds may be made within time limits ranging from 1 to 6 years; in a few states no limit is specified.

Technical Note. Federal and state laws provide for a "standard rate" of contributions. At one time, the standard rate for federal and state law purposes was identical; now this is not always the case. For federal purposes, a state must have a standard rate of at least 5.4 percent if its employers are to obtain the full credit against the federal tax. As a result, the Department of Labor accepts a 5.4 percent rate (or in its absence, the highest rate assigned based on experience) as being the standard rate for federal law purposes. Many states laws use the term standard rate in this sense. Other state laws use the term differently; it may, for example, be the new employer rate.

EMPLOYEE TAXES-Only Alaska, New Jersey, and Pennsylvania levyUIaxes against workers for U1 purposes. The tax base is that applicable to employers except in Pennsylvania where employee contributions are calculated on total gross covered wages paid for employment. Worker taxes are deducted by the employer from the worker's pay and forwarded with the employer's taxes to the state agency. In Alaska, the tax rate is equal to 20% of the average benefit cost rate, but not less than 0.5% or more than 1.0%. In New Jersey, the tax rate is 0.1825% for 2002 and increases to 0.2825% in 2003 and thereafter. Depending on the adequacy of the trust fund balance in a given year, Pennsylvania employees pay contributions ranging from 0.0% to 0.2% on total gross covered wages paid for employment.

INTEREST AND PENALTY FUNDS-In every state an employer is subject to certain interest or penalty payments for delay or default in payment of contributions, and usually incurs penalties for failure or delinquency iAlliling required reports. A11 states except Minnesota have set up special administrative funds, made up of such interest and penalties, to meet special needs. The most usual statement of purpose includes one or more of these three items:

• to cover expenditures for which federal funds have been requested but not yet received, subject to repayment to the fund;
• to pay costs of administration found not to be properly chargeable against funds obtained from federal sources; and
• to replace funds lost or improperly expended for purposes other than, or in amounts in excess of, those found necessary for proper administration.

A few of these states provide for the use of such funds for the purchase of land and erection of buildings for agency use or for the payment of interest on federal advances. In some states the fund is capped; when it exceeds a specified sum the excess is transferred to the trust account or, in one state, to the general fund.

TAXABLE WAGES-More than half of the states have adopted a higher tax base than that applicable under FUTA. In these states, an employer pays a tax on wages paid to (or earned by) each worker within a calendar year up to the specified amount. In addition, most of the states provide an automatic adjustment of the wage base if the FUTA is amended to apply to a higher taxable wage base than that specified under state law.

Some states have established flexible tax bases, i.e., bases that are automatically adjusted, generally on an annual basis. Most of these states key the adjustment to some measure of previous wages.

TYPE OF STATE FUND

The first state system of UI in this country (Wisconsin) set up a separate reserve for each employer. Employer contributions were credited to this reserve and benefits paid to former employees were charged to it as long as the account had a credit balance. Most of the states enacted "pooled-fund" laws on the theory that the risk of unemployment should be spread among all employers and that workers should receive benefits regardless of the balance of the contributions paid by the individual employer and the benefits paid to such workers. All states now have pooled unemployment funds.

All state laws use a system of experience rating by which individual employers' contribution rates are varied on the basis of their experience with the risk of unemployment.

Experience rating systems are designed to encourage employers to stabilize employment, equitably allocate the costs of unemployment, and to encourage employers to participate in the system by providing eligibility information.

FEDERAL REQUIREMENTS FOR EXPERIENCE RATING--State experience rating provisions have developed on the basis of the additional credit provisions of Section 3303(a) FUTA. The federal law allows employers additional credit for a lowered rate of contribution if the rates were based on not less than 3 years of "experience with respect to unemployment or other factors bearing a direct relation to unemployment risk." FUTA allows the states to extend experience-rating tax reductions to new and newly covered employers after they have had at least 1 year of such experience. Further, states allow new and newly covered employers reduced rate (but not less than one percent) on a reasonable basis.

STATE REQUIREMENTS FOR EXPERIENCE RATING--In most states 3 years of experience with unemployment means more than 3 years of coverage and contribution experience. Factors affecting the time required to become a "qualified" employer include:

• The coverage provisions of the state law ("at any time" vs. "20 weeks");



• In states using benefits or benefit derivatives in the experience-rating formula, the type of base period and benefit year and the lag between these two periods, which determine how soon a new employer may be charged for benefits;



• The type of formula used for rate determination; and



• The length of the period between the date as of which rate computations are made and the effective date for rates.

Within the broad federal requirements, the experience-rating provisions of state laws vary greatly. The most significant variations grow out of differences in the formulas used for rate determinations. The factor used to measure experience with unemployment is the basic variable which makes it possible to establish the relative incidence of unemployment among the workers of different employers. At present there are four distinct systems, usually identified as reserve-ratio, benefit-ratio, benefit-wage-ratio, and payroll-decline formulas. A few states have combinations of the systems.

In spite of significant differences, all systems have certain common characteristics. All formulas are devised to establish the relative experience of individual employers with unemployment or with benefit costs. To this end, all have factors for measuring each employer's experience with unemployment or benefit expenditures, and all compare this experience with a measure of exposure--usually payrolls--to establish the relative experience of large and small employers. However, the four systems differ greatly in the construction of the formulas, in the factors used to measure experience and the methods of measurement, in the number of years over which the experience is recorded, in the presence or absence of other factors, and in the relative weight given the various factors in the final assignment of rates.

RESERVE-RATIO FORMULA--The reserve-ratio [(contributions minus benefits charged) divided by payroll] was the earliest of the experience-ratio formulas and continues to be the most popular. It is now used in 33 states. The system is essentially cost accounting. On each employer's record are entered the amount of payroll, contributions, and the benefits paid to workers. The benefits are subtracted from the contributions, and the resulting balance is divided by the payroll to determine the size of the balance in terms of the potential liability for benefits. The balance carried forward each year under the reserve-ratio plan is ordinarily the difference between the employer's total contributions and the total benefits received by workers since the law became effective.

The payroll used to measure the reserves is ordinarily the last 3 years; the following table shows those states that differ from 3 years

Rates are assigned according to a schedule of rates for specified ranges of reserve ratios--the higher the ratio, the lower the rate. Also, fluctuations in the state fund balance affect the rate that an employer will pay; an increase in the fund may trigger a tax rate schedule where a lower rate is assigned and, conversely, a decrease in the fund balance may trigger a tax schedule requiring a higher rate.

1 Formula includes benefit ratio.

BENEFIT-RATIO FORMULA--The benefit-ratio formula (benefits charged divided by employer's payroll) also uses benefits as the measure of experience, but eliminates contributions from the formula and relates benefits directly to payrolls. The theory is that, if each employer pays a rate which approximates his benefit ratio, the program will be adequately financed. Rates are further varied by the inclusion in the formulas of schedules, effective at specified levels of the state fund in terms of dollar amounts or a proportion of payrolls, or fund adequacy percentage.

Unlike the reserve-ratio, the benefit-ratio system is geared to short-term experience. The table below shows the number of years used for each state in determining benefit ratios.

* Rates are also based on the sum of 3 factors- 2 factors that are connected to the employer's experience rate and a state rate to recover noncharged or ineffectively charged benefits.

BENEFIT-WAGE-RATIO FORMULA--The benefit-wage formula is radically different. The formula is designed to assess variable rates which will raise the equivalent of the total amount paid out as benefits. The percentage relationship between total benefit payments and total benefit wages in the state during 3 years is determined. This ratio, known as the state experience factor, means that, on the average, the workers who drew benefits received a certain amount of benefits for each dollar of benefit wages paid and the same amount of taxes per dollar of benefit wages is needed to replenish the fund. The total amount to be raised is distributed among employers in accordance with their benefit-wage ratios; the higher the ratio, the higher the rate.

Individual employer's rates are determined by multiplying the employer's experience factor by the state experience factor. The multiplication is facilitated by a table which assigns rates which are the same as, or slightly more than, the product of the employer's benefit-wage ratio and the state factor. The range of the rates is, however, limited by a minimum and maximum. The minimum and the rounding upward of some rates tend to increase the amount which would be raised if the plan were affected without the table; the maximum, however, decreases the income from employers who would otherwise have paid higher rates.

PAYROLL VARIATION PLAN--The payroll variation plan is independent of benefit payments to individual workers; neither benefits nor any benefit derivatives are used to measure unemployment. Experience with unemployment is measured by the decline in an employer's payroll from quarter to quarter or from year to year. The declines are expressed as a percentage of payrolls in the preceding period, so that experience of employers with large and small payrolls may be compared. If the payroll shows no decrease or only a small percentage decrease over a given period, the employer will be eligible for the largest proportional reductions.

Alaska measures the stability of payrolls from quarter to quarter over a 3-year period; the changes reflect changes in general business activity and also seasonal or irregular declines in employment. Also, Alaska arrays employers according to their average quarterly decline quotients and groups them on the basis of cumulative payrolls in 10 classes for which rates are specified in a schedule.

Since, various methods are used to identify the employer(s) who will be charged with benefits when a worker becomes unemployed and receives benefits, the laws address this in some detail. In the reserve-ratio and benefit-ratio states, it is the workers benefits that are charged; in the benefit-wage states, the benefit wages. There is no charging of benefits in the payroll-decline systems.

In most states, the maximum amount of benefits to be charged is the maximum amount for which any worker is eligible under the state law.

In the states with benefit-wage-ratio formulas, the maximum amount of benefit wages charged is usually the amount of wages required for maximum annual benefits.

CHARGING MOST RECENT OR PRINCIPAL EMPLOYER-States with a benefit-ratio system charge the most recent employer on the theory that this employer has primary responsibility for the unemployment. All the states that charge benefits to the last employer relieve the employer of these charges if only casual or short-time employment is involved. Charging the most recent base period employer assumes that liability for benefits is inherent in wage payments.

CHARGING BASE-PERIOD EMPLOYERS IN INVERSE CHRONOLOGICAL ORDER--Some states limit charges to base-period employers but charge them in inverse order of employment. This method combines the theory that liability for benefits results from wage payments with the theory of employer responsibility for unemployment; responsibility for the unemployment is assumed to lessen with time, and the more remote the employment from the period of compensable unemployment, the less the probability of an employer being charged. A maximum limit is placed on the amount that may be charged any one employer; when the limit is reached, the next previous employer is charged. The limit is usually fixed as a fraction of the wages paid by the employer or as a specified amount in the base period or in the quarter, or as a combination of the two. Usually the limit is the same as the limit on the duration of benefits in terms of quarterly or base-period wages.

If a claimant's unemployment is short, or if the last employer in the base period employed the claimant for a considerable part of the base period, this method of charging employers in inverse chronological order gives the same results as charging the last employer in the base period. If a claimant's unemployment is long, such charging gives much the same results as charging all base-period employers proportionately.

All the states that provide for charging in inverse order of employment have determined, by regulation, the order of charging in case of simultaneous employment by two or more employers.

CHARGING IN PROPORTION TO BASE-PERIOD WAGES--On the theory that unemployment results from general conditions of the labor market more than from a given employer's separations, the largest number of states charge benefits against all base-period employers in proportion to the wages earned by the worker with each employer. Their charging methods assume that liability for benefits is inherent in the wage payments creating the worker's eligibility. (Note that states combining this method with charging the most recent employer are listed on the "most recent" table).

Many states recognize that certain benefit costs should not be charged to individual employers. This has resulted in "noncharging" provisions in practically all state laws using benefits in their formulas. In the states which charge benefits, certain benefits are omitted from charging as indicated below; in the states which charge benefit wages, certain wages are not counted as benefit wages.

The postponement of charges until a certain amount of benefits has been paid results in noncharging of benefits for workers whose unemployment was of very short duration. In many states, charges are omitted when benefits are paid on the basis of an early determination in an appealed case and the determination is eventually reversed. In many states, charges are omitted in the case of benefits paid under a combined wage claim. In Connecticut, Massachusetts and Rhode Island dependents' allowances are not charged to employers' accounts.

Another type of noncharging is for benefits paid following a period of disqualification for voluntary quit, misconduct, or refusal of suitable work or for benefits paid following a separation for which no disqualification was imposed; e.g., because the worker had good personal cause for leaving voluntarily, or because of a job which lasted throughout the normal disqualification period and then was laid off for lack of work. The intent is to relieve the employer of charges for unemployment caused by circumstances beyond the employer's control. The provisions differ with variations in the employer to be charged and with the disqualification provisions, particularly as regards the cancellation and reduction of benefit rights. In this summary, no attempt is made to distinguish between noncharging of benefits or benefit wages following a period of disqualification and noncharging where no disqualification is imposed. Most states provide for noncharging where voluntary leaving or discharge for misconduct is involved and in some states, refusal of suitable work. A few of these states limit noncharging to cases where a worker refuses reemployment in suitable work.

1 Most states limit nonchargimg to specific situations such as benefits paid in excess of amount payable under state law or if claimant would have been ineligible using only the in-state wages.

Four states (Arkansas, Colorado, Maine, and North Carolina) have special provisions or regulations for identifying the employer to be charged in the case of benefits paid to seasonal workers; in general, seasonal employers are charged only with benefits paid for unemployment occurring during the season, and nonseasonal employers, with benefits paid for unemployment at other times. A few states provide that an employer's account will not be charged for benefits paid to an employee who quit to escape domestic violence.

In North Carolina benefits are not charged to employer accounts if paid to an individual who separated from work or refused a job resulting from undue family hardship such as unable to obtain adequate childcare or elder care.

In Oregon the employer is not charged for benefits paid to an individual without any disqualification with respect to a discharge for being unable to satisfy a job prerequisite required by law or administrative rule.

Connecticut has a provision for canceling specified percentages of charges if the employer rehires the worker within specified periods.

The requirements for any rate reduction vary greatly among the states, regardless of type of experience-rating formula. Each state law incorporates at least the federal requirements for reduced rates for individual employers. Many states require that all necessary contribution reports must have been filed and all contributions due must have been paid.

RATES AND RATE SCHEDULES-- Schedules are used to convert the results of the formula used (that is, the reserveratio, benefit-ratio, benefit-wage-ratio or payroll decline) into a tax rate. In a few benefit ratio states, the benefit ratio is itself the employer's rate. Several states use an "array" system where employers are annually ranked against each other, rather than assigned a predetermined experience level. Rate classes in array systems are determined by segregating wages paid by all state employers. For example, the highest rate class will consist of employers with the highest costs. A new rate class will be triggered when employers in the highest class represent a certain percentage of the wages paid under state law. The following states use array systems: Alaska, Idaho, Iowa, Kansas, Maine, Montana, North Dakota, Oregon, Utah, Vermont, Washington.

Tax rates assigned in a state depend on the state's fund balance. In most states, low balances trigger schedules with higher rates and higher balances trigger schedules with lower rates. In some states, the fund balance causes a specified amount to be added or subtracted from the employer's rate. In some states, low fund balances may trigger a solvency tax. (Solvency taxes are discussed later in this chapter.)

In almost all states rates are assigned in accordance with rate schedules in the law.

MINIMUM AND MAXIMUM RATES--Minimum rates in the most favorable schedules vary from 0 to 1.0 percent of payrolls and in no case less than 1 percent for new employers. Only seven states have a minimum rate of 0.5 percent or more. The most common minimum rates range from 0.1 to 0.4 percent inclusive. Maximum tax rates range from 5.4 percent to 10 percent with the maximum rate in more than half the states at 5.4 percent. Note that in some states, the total rate may be the sum of various components which are not distinguished as separate taxes (e.g. nonchargeable benefit components).

LIMITATION ON RATE INCREASES--Wisconsin prevents sudden increases of rates for individual employers by limiting an employer's rate increase in any year to no more than 2 percent than the previous rate. In Oklahoma for employers with rates of 3.4 percent or more, the limitation on the rate increase is 2 percent in any year. For employers with rates below 3.4 percent, their rate may not be increased to