State unemployment insurance reserves won't be enough for a recession

Empty bank vault

Just as a crush of layoffs from the COVID-19 economic crisis begin to put pressure on unemployment insurance systems, a new paper and policy brief examine how state reserves will fare during recession. As the title of the paper, from Christopher O’Leary and Kenneth Kline, puts it: “State Unemployment Insurance Reserves Are Not Adequate.”

O’Leary and Kline find that many states’ unemployment insurance reserves don’t have enough money set aside for a downturn Even a recession of average severityand some economists are predicting the emerging recession will be worse than averagewould cause 18 states to exhaust their unemployment insurance reserves.

The federal-state unemployment insurance system pays a portion of the earnings of people who have become unemployed involuntarily and are looking for work. As it pays out checks to unemployed workers, the system helps stabilize state economies by boosting spending quickly during downturns.

The Great Recession from late 2007 to 2009 drained state reserves, causing most states to borrow money to pay unemployment insurance benefits. Some issued state revenue bonds; even by December 2018, Michigan and Pennsylvania were still paying back debts from such bonds.

Ten states also cut the amount of benefits they paid out. These cuts could make the states’ reserves last further into a recession but the leaner payments to workers won’t spur spending as much.

Reviewing historical data, O’Leary and Kline find that pre-recession reserves should be around 2 percent of total wages or 5 percent of taxable wages. By the end of 2018, after years of economic growth, reserves were at only 1 percent of total wages and less than 4 percent of taxable wages.

Simulating effects of mild, moderate and severe recessions for the reserves of 53 U.S. states and territories, the researchers find that the reserve funds of 11, 18 and 21 states, respectively, would be in the red. A severe recession would further generate a system-wide debt of $3.8 billion.

O’Leary and Kline propose financing changes to help shore up the unemployment insurance system. One such change would be increasing the federal taxable wage base, which sets the floor for state taxable wage bases, and indexing it to adjust annually for inflation.

Experts

Christopher J. O'Leary headshot

Christopher J. O'Leary

Senior Economist
Kenneth Kline headshot

Kenneth Kline

Senior Research Analyst

Research Topics: Unemployment Insurance