OLR RESEARCH REPORT
December 31, 1998
UNEMPLOYMENT INSURANCE - REVENUE SOURCE AND EXPLANATION OF STATE AND FEDERAL FUNDS
By: Laura Jordan, Research Attorney
You asked for an explanation of how the state assesses employers for unemployment compensation (UC) taxes. You also asked for a description of the state's Unemployment Compensation Fund (the “state fund”), and the Unemployment Compensation Advance Fund (the “advance fund”), and the federal Unemployment Trust Fund (the “federal fund”).
The state fund pays claimant benefits and the Department of Labor's Employment Security Division's administrative costs. Employer taxes and federal appropriations finance the state fund, which is located in the federal federal fund. Federal law requires the state to immediately deposit all taxes it collects from employers into the federal fund. It prohibits states from withdrawing state funds except to pay claimant benefits (26 U.S.C.∋ 3304(a)(4)). Interest earned on a state's fund is paid to its fund and must also be used exclusively for benefits.
Employer state UC taxes are used exclusively to pay benefits. An employer's tax liability depends on three factors: (1) the amount of wages he paid that are included in the taxable wage base set by the state; (2) the amount of unemployment benefits paid to the employer's workers over a specified period of time (called the charged, merit, or experience rate); and (3) the solvency of the state's unemployment compensation trust fund (called the solvency, flat rate or fund balance tax). To determine the amount of taxes owed, an employer adds his charged rate to the flat rate to come up with his total tax rate, and then multiplies this by his taxable wages.
The advance fund repays bonds authorized in 1993 to bail out the state fund. State law allows the advance fund to (1) be used to pay federal debt (the state currently has no federal debt) and advance fund administrative costs and (2) to advance benefit funds to the state fund. State law requires any interest earned on investments made with advance fund amounts to be paid to the advance fund (CGS ∋ 31-264a(g)). Unlike the state fund, which must be in conformance with federal requirements, the state is entirely free to establish its own rules concerning organization, funding, and operation of the advance fund.
Employers finance the advance fund through a special tax (sometimes referred to as a bond assessment) scheduled to end in 2001. An employer's advance fund tax rate is determined by multiplying its (1) annually assigned charged rate by (2) the annual bond rate set by the state treasurer. This rate, known as the “revenue ratio,” reflects the amount that the treasurer determines is needed to pay a specific year's bond debt. It is currently .513%. The amount an employer owes in taxes is determined by multiplying his tax rate by his taxable wages.
In addition to the two state taxes described in this summary, employers pay a federal unemployment compensation tax that the state plays no role in collecting. This tax largely pays for state administrative costs. Connecticut employers receive a federal corporation tax credit of up to 5.4% to offset their state UC taxes.
UNEMPLOYMENT COMPENSATION FUND
The Fund's Structure
The U.S. Treasury Secretary manages all states' UC funds, which are held in the federal fund. All states must deposit funds they receive from employer taxes to a depository designated by the treasurer (26 U.C.A. ∋ 3304(a)(3) and (4); 42 U.C.A. ∋ 1104(a)). Federal law requires the treasurer to invest the portion of the trust fund that in his judgment will not be needed to pay current benefits. Interest earned on investments is returned to the trust fund and state accounts receive quarterly credits for their share of investment interest (42 U.C.A. ∋ 1104(b) and (c)). The Secretary must pay the state its funds upon demand (42 U.C.A. ∋ 1104(f)).
The state's UC fund has two components. The Unemployment Compensation Benefit Fund is used exclusively for benefit claims, and the Employment Security Administration (ESA) Fund holds state and federal money that the state's Employment Security Division uses to administer programs required by the Job Training Partnership Act (which Congress repealed this past summer), Work Incentive Program, Trade Adjustment Act, Veterans Employment Service, and the Bureau of Labor Statistics (CGS ∋ 31-259(a)).
A third fund, the Employment Security Special Administration (ESSA) fund, is separate from the state fund (CGS ∋ 31-259(d)). This fund consists of interest on overdue UC taxes. It pays for administering the UC law and for any other purpose authorized by state law. No more than $500,000 can remain in the ESSA Fund on any July 1. Any excess, minus any previously committed expenditures, is transferred to the state fund.
An employer's UC tax liability is determined by adding its annually assigned charged tax rate to the fund balance rate and multiplying this total by the employer's taxable wages. Federal and state laws cover virtually all employers, but a few are exempt. In general, nonprofit organizations and government entities can choose to either pay the UC tax or to reimburse the fund for benefits paid out on behalf of their workers. Also, some employers such as churches and church-supported charities are exempt from UC taxes, but may pay taxes voluntarily.
The Taxable Wage Base. Both federal and state laws establish a level of wages subject to taxation. The Federal Unemployment Tax Act (FUTA) taxable wage base is $7,000 (i.e., the first $7,000 paid to each employee of each year)(26 U.S.C. ∋ 3306(b)(1)). States' taxable wage base must be at least this high. Connecticut's taxable wage base is currently $13,000 and is scheduled to increase to $15,000 on January 1, 1999. Historically, the state's wage base has been $9,000 in 1994; $10,000 in 1995; $11,000 in 1996; and $12,000 in 1997.
The state's definition of taxable wages automatically includes all remuneration subject to FUTA (CGS ∋ 31-222(b)(3)). Certain types of employer payments are excluded under both laws.
The Charged Rate. FUTA requires states to use an experience rating system to assess employers for UC taxes and requires that the experience period be at least three years (26 U.S.C. ∋ 3303(a)). Within these constraints, states may structure their own tax systems. The two most popular systems are the reserve and benefit ratio systems. Connecticut uses the latter system, along with 14 other states. Under the benefit ratio system, tax rates are based on the ratio of an employer's benefit charges over a certain period (three years in Connecticut) to its payroll over the same period. Under the reserve ratio system used by 32 states, all benefits ever charged to an employer are subtracted from all the taxes it has ever paid into the fund. The result is then divided by its average payroll for the preceding three years.
The maximum experience rate yields a standard percentage of 5.4% in Connecticut. This is also the maximum federal experience rate and the maximum FUTA credit (26 U.S.C. ∋ 3302(b)). Federal law requires that a new employer pay taxes at the maximum experience rate until it has accumulated sufficient experience to allow its taxes to be computed in accordance with that experience (26 U.S.C. ∋ 3304(a)(3)). Originally, FUTA required new employers to pay the maximum for at least three years. In 1954, states were permitted to lower the requirement to one year, and in 1970 FUTA was amended to allow states to assign reduced rates to new employers on a reasonable basis as long as the experience rate was not less than 1%. Connecticut law requires new employers to pay a set experience rate until their experience account has been chargeable with benefits for at least one full experience year. The state's experience year runs from July 1 to June 30. The experience rate for new employers is 1% or the state's average five-year benefit-cost rate, whichever is higher, up to a maximum of 5.4% (CGS ∋ 31-225a(a) and (d)). If a business is transferred to another employer during the year and the successor has no previous experience rate, the old employer's experience rate is continued under the new employer.
The Fund Balance Rate. On top of the charged rate, each employer is charged the same flat tax rate known as the fund balance rate. This rate is tied into the solvency of the State Fund and is set each December 30 by the labor commissioner.
In 1993, the General Assembly increased the maximum fund balance tax rate from 1% to 1.5% until January 1, 1999, and 1.4% thereafter. It capped the permitted surplus in the State Fund at 0.8% of the state's total annual payroll and required the fund balance tax rate to be reduced if the fund balance exceeds the cap (PA 93-243). The total annual payroll is the total wages paid to employees covered by the UC law by employers who pay unemployment taxes each year. If the fund balance exceeds that percentage on December 30 of any year, the labor commissioner must reduce the tax rate enough to eliminate any surplus.
Due to the maximum charged and balance rates, the highest UC tax rate any employer pays is currently 6.9% (5.4% maximum charged rate + 1.5% maximum fund balance rate). After January 1, 1999, the highest rate will decrease to 6.8%.
Table 1: Example 1
If an employer's charged rate is 2.0 and his taxable wages are $90,000, his tax liability is $3,150.
2.0% (charged rate) + 1.5% (current fund balance rate) = 3.5% (the employer's tax rate)
3.5% X $90,000 (employer's taxable wages) = $3,150
UNEMPLOYMENT COMPENSATION ADVANCE FUND
The Fund's Structure
The state established the advance fund in 1993 to receive revenue from bonds and employer assessments related to the 1993 bailout of the state fund, which owed the federal fund approximately $900 million. The advance fund can receive any federal funds the state receives related to the repayment of the bonds, and any interest or investment income earned on money deposited in it. The state treasurer administers the advance fund. All administrative costs of establishing and running the advance fund, issuing the revenue bonds, and collecting the assessments from employers are chargeable to the fund.
The advance fund contains three subaccounts: (1) the advance account, (2) the debt service and reserve account, and (3) the administration account. The law allocates revenue to each of them from the revenues available to the fund. It also sets up a procedure for the labor commissioner to request money from the advance fund to pay benefits or federal debts.
An employer's advance fund tax liability is based on three factors: (1) his charged rate (which can range from 0.5% to 5.4%); (2) his total taxable wages; and (3) the revenue ratio. The treasurer, at least annually, sets the revenue ratio by determining the interest, amortization, reserve, and associated costs attributable to each advance from the advance fund. The labor commissioner levies employer assessments to cover all these costs. Historically, the revenue ratio has been .34% in 1994; .37% in 1995; .458% in 1996; .46% in 1997; and .513% in 1998.
The tax liability is determined by multiplying the revenue ratio by the employer's charged rate and then multiplying this product by the employer's taxable wages.
Table 2: Example 2
If an employer's taxable wages are $90,000 in 1998 and his charged rate is 2.0, then the amount of advance fund taxes he owes is $923.40.
.513% (the 1998 revenue ratio) X 2.0% (the employer's charged rate) = 1.026%
1.026% (the employer's advance fund tax rate determined above) X $90,000 (employer's taxable wages) = $923.40