Why Don’t Employees Pay for Unemployment Insurance?
Before you start calling me bad names, let me assure you that even Mr. ToughMoneyLove has sympathy for the unemployed. I am so grateful that I am not one of them. For any of you out there looking for a job in this awful economy, I truly hope you find one ASAP. Just don’t assume that President Obama will dump one in your lap anytime soon. (That’s a story for another day.)
It’s not that I don’t want the unemployed to have some income when they can’t find a job. It’s that I’m not sure that the system we have in place to finance unemployment benefits is a good one.
First, a little review. The unemployment insurance system is jointly operated by the state and federal governments. It is financed by state and federal payroll taxes. Under the Federal Unemployment Tax Act (FUTA), the federal tax rate is 6.2% of taxable wages applied to the first $7,000 of income. Most of the federal payroll tax can be offset by state unemployment taxes, which vary from state to state, as do the benefits. All of the state and federal unemployment insurance payroll taxes are paid by the employer. This is the part that I question.
I am part owner of a small business and have some familiarity with the unemployment insurance system. For one thing, the state payroll taxes in many states are experience rated. This means that if an employer has an ex-employee claim and receive benefits, unemployment taxes go up. This creates incentives for employers to fight unemployment claims made by employees who quit or who are fired because they do a lousy job or suffer from frequent bouts of the Napa Valley flu a/k/a recurrent hangover disease. (Yes, we had one of those working for us for a while.) The problem is that to fight a claim, you could end up having to appear in front of a state hearing officer or administrative law judge for a mini-trial, etc. That’s usually more trouble than it’s worth. I actually represented our business at one of those hearings. Without going into detail about the testimony from the former employee, the word “fabrication” sticks prominently in my mind.
Now let’s say you are a small business in Massachusetts, which is relatively generous in its benefits. (No surprise there – it’s the ancestral home of the Kennedy clan as well as dear Barney Frank.) The unemployment tax rate in Massachusetts can go as high as 10.3% and the weekly benefit can be as much as $900 (if you have lots of dependent children). I don’t know about you, but I could do OK for a while on $900/week tax deferred. We have had a few employees go through the same analysis with not so generous benefits. Quitting (or forcing a termination) and claiming unemployment is sort of like a mini-vacation to them. You can tell when that happens because a new job suddenly materializes only when their unemployment benefits run out. Meanwhile, our tax rate goes up.
So why don’t employees pay unemployment insurance premiums? Is it fair that employers carry all of the risk even when some employees can obtain benefits by quitting or getting fired? When employers are forced by economic conditions to reduce payroll, whose fault is that? And when Congress decides to extend enemployment benefits (like it has been doing serially in recent months), we are all paying for that with our tax dollars because there are not enough employer-financed premiums in the system.
I think maybe we should treat unemployment insurance taxes like the Social Security payroll tax but with a twist. Employers and employees each contribute, just as they do for Social Security. That way, they share the risk. The twist is that some of the unemployment payroll taxes are credited to the employee’s personal account. If the employee and employer do well and no one loses their job, perhaps some of the unemployment insurance taxes can be invested and returned to the employee as an extra retirement benefit. That creates a positive incentive for all employees to work hard and stay employed.
FUTA has been around since 1935. The tax rates and wage base hae been tweaked but not much else has changed since then. I’m not an actuary so I might be overlooking some critical factor in my analysis. Maybe someone can explain to me why the present system of financing unemployment benefits is the only one that works. Considering that the government designed the system to begin with, I doubt it.
How about it readers? Do you think change is needed?
Image credit: Ayhan YILDIZ