Unemployment 101: Who pays for jobless benefits, anyway?

The Obama administration is trying to change the way the unemployment insurance system is funded.

The administration claims that its plan – to be unveiled when President Obama proposes his 2012 budget on Monday – prevents a tax increase on business and helps cash-strapped states.

Republicans call it a "job-destroying” tax hike on business and a bailout for states that are overly generous with their jobless benefits. Here are some fundamental questions and answers concerning how the unemployment insurance system works.

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What’s behind this battle?

At the moment, employers pay a state tax for each employee. The money pays for all those state-issued unemployment checks – the first 26 weeks of them, anyway.

Employers also pay a per-employee federal tax, which funds administrative costs of implementing the system.

But because the unemployment rate – now at 9 percent – has remained relatively high for so long, 30 states have exhausted their funds and have had to borrow $41 billion from Uncle Sam. The biggest borrowers are California, Michigan, New York, Pennsylvania, and Illinois.

If Congress makes no changes in current law, states will start paying interest on these loans in September. (They got a break from paying interest under the president’s tax stimulus bill, but that reprieve expired on Jan. 1.) To fund those interest payments, states probably will add a "special assessment" on businesses within their boundaries.

To pay the principal, federal taxes on employers will go up in borrowing states, under current law. Those higher federal taxes will start hitting businesses this year and will stay higher until the loans are paid off – which will take more than a decade in many states, by some estimates.

“There are going to be tax increases on employers in states that have borrowed [to cover unemployment benefits], unless something is done,” says Mike Leachman, assistant director of the State Fiscal Project at the Center on Budget and Policy Priorities (CBPP) in Washington. “That means taxes will be going up both this year and next year, when the economy is still weak, and they could be at very high levels late in the decade.”

How would the Obama proposal change this?

The president's proposed budget is expected to include a two-year postponement of the special "state assessment" tax hikes on business, plus a similar delay in any increase in federal unemployment insurance taxes.

That's the carrot.

Here's the stick.

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