States’ Unemployment Insurance-Financing Systems Limit the Degree of Experience Rating

tax rates, and (2) the equitable allocation of costs of unemployment  benefits.  . Nearly All States Base Experience-Rated Tax Rates on Benefits Paid to a Firm’s Former Workers

All state unemployment insurance programs adjust the tax rates of  individual firms on the basis of their experience with unemployment, and  50 of the 53 systems do so based on one of two basic systems—the  reserve ratio system or the benefit ratio system. Maximum Tax Rates

While all states vary an employer’s tax rate on the basis of experience  rating, all states have also established maximum tax rates that limit an  employer’s tax liability. In a single year, the employer’s workers would receive about  $31,500 more in benefits than taxes paid by the employer. Minimum tax rates ensure that an employer’s tax  rate will not drop below a specified floor, no matter how much its  experience rating improves. Benefits Charged to Inactive Firms

State unemployment programs also pay benefits to unemployed workers  whose former employer has gone out of business. The studies  we reviewed found that such cross-subsidies favor seasonal and cyclical  industries, such as construction and agriculture, forestry, and fisheries,  whereas firms in the finance, insurance, and real estate industry regularly  pay subsidies. Studies have also found that new firms  that are not yet experience-rated, regardless of industry, tend to pay  subsidies. According to the studies, certain industries, such as construction and  agriculture, consistently received subsidies, which can be substantial. Our more recent tax data also show a similar pattern with regard to those  industries that paid subsidies. Among the several ways states  could improve experience rating, some of the key adjustments would be to  raise the maximum tax rate, increase the taxable wage base, or adopt  some combination of these two modifications.A 2003 analysis of the  Massachusetts unemployment insurance program indicates that making an  adjustment can have a substantial effect on closing the gap between  benefits charged to and taxes paid by firms that get a subsidy. Reducing Noncharged Benefits Would Restrict UI Eligibility or Impose Additional Costs on Employers

Noncharged benefits—benefits payments that are not charged to a specific  employer—detract from experience rating because they are shared—that  is, they are borne to some degree by all employers, thus adding to the  costs of employers who had no responsibility for the unemployment. However, each approach has its drawbacks. Concluding Observations

Cross-subsidies in state unemployment insurance systems are a long- standing part of the system, and the subsidies occur because  unemployment insurance taxation systems are not fully experience- rated—a fully experience-rated system would ensure that, over time, the  costs that an employer imposed on the unemployment insurance programs  were equal to the taxes it paid. Several aspects of state unemployment  insurance systems cause this shortfall from full experience rating, and  states could improve experience rating and reduce these cross-subsidies  by adjusting these aspects. Under the current framework, state  policy makers decide the appropriate balance between experience rating  and the other policy objectives of a state’s unemployment insurance  program. Agency Comments and Our Evaluation

We provided a draft of this report to the Department of Labor for its  review. How have states ensured that individual employers pay unemployment  insurance taxes based on their experience with unemployment, and  what aspects of state unemployment insurance systems limit such  experience rating? To what extent do employers pay unemployment insurance taxes  commensurate with unemployment benefits paid to their former  employees, and how does this vary by industry? 3.
Why GAO Did This Study

In 2006, the Unemployment Insurance (UI) program is expected to collect over $37 billion in taxes from employers to pay $34 billion in benefits to unemployed workers. Under state UI programs, employers' tax contributions are experience-rated--that is, they reflect the extent to which they laid off workers who then collected benefits. To examine the equity of this system, we met with officials from five states, reviewed prior studies, and examined state data to determine (1) how states ensure that employers pay UI taxes based on their experience with unemployment, and the aspects of state unemployment insurance systems that limit experience rating; (2) the extent to which employers pay unemployment insurance taxes commensurate with unemployment benefits paid to their former employees; and how this varies by industry; and (3) steps states could take to increase the degree of experience rating. We provided a draft of this report to the Department of Labor (Labor) for its review. Overall, Labor agreed with our findings.

What GAO Found

All state Unemployment Insurance-financing systems are experience-rated, but several aspects of these systems limit the connection between an employer's tax contributions and the employer's experience with unemployment. For example, a state's maximum tax rate limits the size of an employer's tax payment, regardless of the costs an employer may have imposed on the system. Similarly, a minimum tax rate ensures that an employer's tax rate will not drop below a specified floor, no matter how much its experience rating improves. Other aspects of state systems allow the cost of some benefits to be charged to all employers rather than to a single employer. These shared costs include, for example, benefits paid to unemployed workers of a firm that has gone out of business. When the cost of benefits is shared in this way, it reduces experience rating and imposes additional costs on all employers. A series of studies that examine experience rating in state UI systems show that a number of industries used more in benefits than they paid in taxes to finance the system. Certain industries, such as construction and agriculture, forestry, and fisheries, as a whole, consistently received such subsidies, while other industries, such as finance, insurance, and real estate tended to pay subsidies. Newer firms that are not yet experience-rated, regardless of industry, also tend to pay subsidies. Our analysis of more recent data from three states found a similar pattern of subsidies. States could increase experience rating and reduce subsidies by adjusting aspects of the unemployment insurance tax structure, such as the maximum tax rate. However, each of these adjustments has trade-offs that would have to be considered by a state because the adjustments would raise costs for some employers or reduce costs for others. In addition, such adjustments would have to be evaluated based on the implications for other policy objectives established for a state's unemployment insurance program.