Unemployment 101: Who pays for jobless benefits, anyway?

Employers pay state and federal taxes to cover all those unemployment checks. But with unemployment at 9 percent, those taxes aren't enough, leaving some states in dire straits.

By , Staff writer

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    In this Jan. 26 photo, job seekers line up for a job fair at a hotel in Dallas.

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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.

In 2014, Mr. Obama would deepen the wage base on which employers pay for unemployment. Currently, companies pay their federal unemployment tax on the first $7,000 of each employee’s salary. That rate has been the same since 1983, when Ronald Reagan was president. Obama is expected to ask that the base level for the tax be raised to $15,000, or about where it would be if it were adjusted for inflation. Because states are required to set their wage bases at least at the federal level, the increase would mean that states with wage bases of less than $15,000 would have to increase them to at least that level.

Won’t that be a tax increase?

It could be. Each state would have the option to adjust the rate that companies in their state pay. A state could actually cut the rate, if its unemployment fund became solvent as the economy recovered.

How much do companies currently pay?

The average state unemployment insurance (UI) tax in 2008 was $274 per employee, according to CBPP.

The basic federal tax is $56 per employee, but this will start increasing in $21-per-employee increments over the next two years, if no action is taken by Congress.

Are there other plans?

Yes. On Wednesday, the CBPP proposed a gradual increase in the wage base, a moratorium on state interest payments on their UI loans, and a postponement for two years on the federal tax increases currently mandated to repay the loan principal.

Also on Wednesday, the Center for American Progress think tank proposed that the US government forgive loans to states that have borrowed to keep their unemployment insurance systems solvent. It proposes rewarding states that have maintained positive balances. In addition, the center's plan would increase the federal government’s role during times of high unemployment and reduce the wide disparity in eligibility rules and benefits across the states.

Do the Republicans have a plan?

House majority leader Eric Cantor of Virginia suggests immediately suspending the federal unemployment tax, to save employers $56 per worker per year.

This would cost $7 billion a year. “With the spending we are cutting, I don’t think finding offsets is a problem,” says Brendan Buck, a spokesman for House Speaker John Boehner of Ohio.

Republicans would also require that people receiving unemployment checks work in a part-time job for a six-week trial period. Cantor says this results in faster returns to work and fewer unemployment payments, thus lowering state unemployment taxes.

What is the likelihood Congress will approve Obama’s plan?

Republicans now control the House of Representatives, and some of their key leaders have already said they oppose the Obama plan. In the Senate, Sen. Orin Hatch (R) of Utah is opposed to the plan, calling it "job-destroying."

RELATED: Job market's still tough. Seven ways to reenergize your job search.

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