Explainer on the Unemployment Insurance Trust Fund and Taxes

Episode 3 – Trust Fund and Taxes:

For the third installment on Idaho’s unemployment insurance (UI) program, we explain the UI Trust Fund and its influence on the taxes employers pay.

The Trust Fund:

The UI Trust Fund is the center of the UI program.

The most basic function of the UI Trust Fund is as the pool where UI taxes Idaho employers pay are deposited and from which benefits paid to claimants are withdrawn. The diagram of figure 1 compares it with a holding tank shaped like Idaho. As the amount of funds in the tank goes up or down, it determines the tax rates on employers.

Trust Fund Graphics

All 50 states, Washington, D.C. Puerto Rico and Virgin Islands have a UI Trust Fund. The Federal Unemployment Tax Act (FUTA) requires the UI trust funds be kept with the Unemployment Trust Fund at the U.S. Treasury, and the funds can only be used to pay unemployment benefits.

Idaho code establishes a formula that uses the UI trust fund as the central mechanism to determine the unemployment insurance tax rate for each business.[1] This formula takes into account the current balance of the unemployment insurance trust fund relative to total wages and the amount of money it will need during a potential recession.

The formula first calculates a measurement of the trust fund’s current level with the size of Idaho’s growing economy. It does this by taking a ratio of its balance with total wages paid by experience-rated employers during a full calendar year. If the ratio is comparatively low the formula will want to increase taxes to replenish the fund. Conversely, if it is relatively high, it will want to decrease taxes to keep the fund level from becoming larger than necessary.

Technical note: “Experience-rated” simply refers to employers covered under unemployment security law who contribute funds to the program. Other employers are known as “cost reimbursable.” These include not for profits, government and others that while not exempt from the law, do not pay into the trust fund via taxes. Rather, they have opted to reimburse the fund directly for unemployment insurance benefits paid on their behalf. While they still report wages to the Idaho Department of Labor, they are excluded from the fund balance ratio.

The formula then calculates the level of funding needed for the trust fund to be financed well-enough to withstand potential recessionary risk. The formula looks at the three highest cost benefit years over the past 20-year period to account for the severity of a possible draw on the trust fund (Figure 2). Because this is a moving scale that uses the most recent 20 years, the current three highest cost years are 2002, 2009 and 2010. When the UI tax rates for the year 2024 are determined, 2002 will be replaced with 2003. And in 2025 the years 2009, 2010 and 2011 will be used when 2003 rolls beyond the rearview mirror.

Figure 2

The formula then applies “the desired fund size multiplier” [2], that is set in code at 1.3. The straightforward arithmetic interpretation is it increases the desired solvency level of the trust fund to 30% above where the formula would peg the size of the fund to be without it. Another way to understand the 1.3 multiplier is that it sets the size of the trust fund to be able to withstand 15.6 months of benefit payments (12 months * 1.3 = 15.6 months) if unemployment benefits were withdrawn at the same rate as the average of the three highest cost years.

Historical note: In 2005, the desired multiplier was set at 0.8.[3] Two years later, the Great Recession started in 2007 and by 2010 the UI trust fund become insolvent and went broke. Idaho had to borrow from the federal government to continue paying benefits. As a result, tax rates rapidly increased from 2010 to 2013 to restore the UI fund to solvency.

The outcome after the multiplier is applied is used by the formula to determine the base rate calculation for employers.

The formula provides a data-informed strategy designed to keep the trust fund solvent, stable and predictable. Maintaining solvency is crucial for the UI Trust Fund in order to keep tax rates consistent and steady for employers. During economic downturns, having a solvent trust fund limits wild swings in tax rates when employers can least afford it. According to the 2021 State Unemployment Insurance – Trust Fund Solvency Report[4], Idaho’s is the fourth most solvent in the nation. Idaho can be assured the existing fund balance is financed well to avoid volatile and spiking state UI tax rates without the need to issue bonds or borrow from the federal government and become burdened with the associated FUTA penalties.

During the pandemic, when the trust fund was decreasing due to all of the pandemic related claims being paid, to increase solvency and to prevent a large tax increase on Idaho employers, Gov. Brad Little approved a $200 million transfer of CARES Act funding to the UI Trust Fund. This raised the level of the tank and covered all the pandemic-related claims and then some.  This resulted in a decrease in taxes for Idaho businesses. The transfer of CARES Act funding allowed for a one-time base tax decrease of 18.5% in 2021. The formula triggered a corresponding increase in 2022 to keep fund solvency levels where they need to be.

Gov. Little also proposed freezing the 2022 and 2023 tax rates at the 2021 level. Freezing the rates would save employers $64 million from tax increases that would have come into effect. This proposal was passed by the legislature and signed into law on Feb. 18, 2022. The fund’s solvency was not changed, but the freeze optimized the timing of anticipated changes to the cost structure (Figure 3) related to the change in which years were used for the three highest cost years.

Figure 3

Unemployment Insurance Taxes on Employers

From the calculation of the UI Base Tax Rate, the array set by Idaho code determines the tax-based employer’s experience rating (Figure 4) within FUTA guide rails. The maximum rate employers pay is 5.4%, but it can go up to 6.8% in times when the trust fund is about to become insolvent in order to replenish funds.

Figure 4: 2022 employer UI tax rates

The actual amount an employer pays is determined by three things: the number of employees, the taxable wage base and the experience rating of the employer.

The taxable wage base is also known as the maximum taxable wage base (MTWB), which is the ceiling of earned income that employers must pay unemployment insurance taxes on. Idaho is one of a handful of states that automatically index their MTWB against inflation, wage growth and the associated liability of an economically growing and thriving state. In some states with low taxable wage bases, less than one third of total wages are even subject to UI taxes, placing a larger burden on smaller employers paying lower wages. A higher MTWB makes the taxable income more equitable across all income levels. For 2022, Idaho’s MTWB calculation was at $46,500.

The third factor is experience rating. Idaho and every other state use an experience rating system as required by federal law. This has been an element of UI programs since its beginning and serves the same function of any other insurance system; it varies the rates charged to customers based on their calculated level of risk. For UI, it means that employers whose workers draw more benefits than the employers pay into the system receive higher tax rates, and vice versa. Employers paying more in taxes than charged for benefits to claimants are referenced as positive rated, and those with more benefits than they have paid in taxes fall into the negative or deficit-rated array.

Idaho’s UI tax system is structured in a way that allows for most employers to be distributed across the positive-rated categories with low rates – significantly lower rates than the maximum levels. For example,4.6% of active employers are in deficit and taxed from 1.245% to 5.4% while all others are taxed at 1% or lower if experienced rated.

Idaho’s standard rate for new employers is 1%, the lowest legal level set to conform with federal law. Idaho’s law is designed to not put existing Idaho employers at a competitive disadvantage by ensuring the existing positively experience rated employers’ rates are lower than new employers without an experience rating.

The FUTA does not force states to have their own UI program. However, without it, Idaho employers would pay 6% in UI taxes to the federal government. Idaho having its own UI program provides a discount to the federal FUTA tax. On average, Idaho employers pay 30% of what the FUTA tax would be if Idaho did not have its own UI program.

Emerging from the pandemic, 40% of states are seeing tax hikes to replenish their trust funds and repay debt, while some risk absorbing federal FUTA penalties, interest on borrowing and waiting for the next volatile tax hike when the business cycle takes a turn for the worse. Idaho is loan and bond free with the lowest rates on record and a solvent UI trust fund that is well positioned to weather a recession akin to the most recent “Great Recession.”

 

– Craig Shaul, research analyst supervisor, Idaho Department of Labor

 

[1] Idaho Statute: Title 72 Worker’s Compensation and Related Laws

[2] Idaho Code 72-1350

[3] 2019 Idaho Department of Labor Redbook

[4] USDOL: State Unemployment Insurance Trust Fund Solvency Report, 2021

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Part One: Idaho’s Unemployment Insurance Program Part of a National System

Part Two: Explaining Idaho’s UI Tax System – Claimants and Benefits

2 thoughts on “Explainer on the Unemployment Insurance Trust Fund and Taxes

  1. Pingback: Explaining Idaho’s UI Tax System – Claimants and Benefits | idaho@work

  2. Pingback: Idaho’s Unemployment Insurance Program Part of a National System | idaho@work

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