Is our Unemployment Insurance system recession-ready?

The Great Recession severely drained state unemployment insurance (UI) reserves. As of January 2016, there were still 10 states paying for federal loans or bonds taken on during the recession. If the current economic recovery falters and a recession sparks a new round of layoffs, could states meet their UI obligations?

A new Upjohn Institute working paper, “Are State Unemployment Insurance Reserves Sufficient for the Next Recession?” by Christopher J. O’Leary and Kenneth J. Kline, investigates this question.

While the U.S. Department of Labor encourages adequate forward funding by offering interest-free, short-term loans to states that satisfy accepted reserve requirements, some states prefer a pay-as-you-go financing system. These states keep UI taxes on employers low and use tax-exempt bonds to finance benefit payments when necessary.

In the current low-interest environment, this choice makes economic sense. But, as the authors warn, if interest rates rise, those states could find themselves saddled with unexpected debt.  Furthermore, the pay-as-you-go strategy weakens the automatic countercyclical macroeconomic mechanism established by a forward funded UI system.

Historical trends suggest current UI reserves remain underfunded. To be adequately prepared for a future severe recession, simulations suggest prerecession reserves should be about 2.0 percent of total payrolls or 5.0 percent of taxable payrolls. Yet, after several years of economic growth and labor market improvement, by the end of 2015 system net reserves had not reached even half these levels. 

Nine states responded to debt in the Great Recession by reducing the potential duration of UI benefits to less than 26 weeks. Of these, only Arkansas, Florida, and Kansas now have sufficient reserves to ride out an “average” recession without borrowing. Simulations of expected state borrowing in the event of a near-future recession suggest that up to 30 states could be forced to borrow to pay for UI, depending on the severity of the recession. Following prior federal practice, states that have shortened potential benefit durations would also receive shorter benefit extensions under any future federal emergency program, thus lengthening any future recession and weakening economic recovery.

O’Leary and Kline recommend that states increase reserves to forward fund UI benefits. They note that more than half of state taxable wage bases for unemployment tax are less than double the federally required minimum taxable wage base of $7,000, and that while this base was once equal to the Social Security taxable wage base it has not been adjusted since 1983.  An increased federal taxable wage base would also increase funding for reemployment services, state program administration, and loan reserves.

Read “Are State Unemployment Insurance Reserves Sufficient for the Next Recession?” by Christopher J. O’Leary and Kenneth J. Kline.


Research Topics: Unemployment Insurance