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Think Your State Is Ready for the Next Recession? Better Check This Fund First.

State unemployment insurance trust funds were decimated during the last recession. A decade later, many still don't have the funds to weather the next downturn.

During the Great Recession, many states, including California, saw record numbers apply for unemployment insurance. Now, almost a decade later, many of those funds don't have enough money to weather the next economic downturn.
(AP/Rich Pedroncelli)
States have done a lot over the past decade to be better financially prepared for the next recession. But one area many have ignored is -- ironically -- their unemployment insurance programs for laid-off workers.

More than half of states’ unemployment insurance trust funds don’t have enough money in them to weather the next economic downturn, according to the most recent federal report on the funds. Of the 28 that don’t meet the minimum solvency level recommended by the U.S. Department of Labor, a whopping 11 have less than half of the funds needed to meet a downturn.

The lack of recovery in many funds more than a decade after the last recession began is alarming given that many think time is running out on the current economic expansion. "If there’s another bad recession like the last one,” says Christopher O’Leary, a senior economist at the W.E. Upjohn Institute, "states, on average, are not prepared.” 

During the last recession, unemployment insurance funds were decimated as an unprecedented number of claims depleted balances. Payments went from a total of $30.5 billion in 2006 to a peak of $75.8 billion in 2009, with a historic 30 states borrowing money either from the federal government or the bond market to cover them.

Unemployment insurance has long been seen as an economic shock absorber during downturns. Workers count on the partial income replacement to help cover expenses while they look for another job. And for governments, the insurance keeps those residents out of poverty and lessens the pressure on other state social services programs.

What's more, the insurance keeps money circulating in the economy during a downturn. According to one estimate, this economic stimulus saved 1.75 million jobs during the last recession.

Or at least that used to be the case. Following the Great Recession, several states have stabilized their trust funds by cutting benefits. North Carolina, for example, has $3.1 billion -- more than what it needs to meet the solvency test on paper. But, as Urban Institute expert Wayne Vroman notes, it has achieved that balance largely by cutting insurance benefits by 80 percent, including limiting payouts to just 12 weeks instead of 26 weeks. (Other states that have substantially cut benefits include Alabama, Arizona, Florida, Georgia, Kentucky and Missouri.)

Cutting benefits, says Vroman, ultimately makes downturns harder to recover from. Unemployment insurance, he says, "performs less well as a stabilizer because [states are] paying out less in a recessionary period."

Another factor hurting states is that many of them aren't properly funding unemployment insurance in the first place. States finance their programs through a tax on employer payrolls. But 32 states only levy the tax on a small share of employee wages ranging from the first $7,000 to the first $15,000. That, most economists agree, is not enough to build up a proper reserve in economic expansion periods.

California offers the best example of this financing imbalance. It’s home to some of the highest average wages in the country. Yet the state has kept its unemploymen insurance taxable wage base at the federal $7,000 minimum for the past 40 years. More than any other state, it has relied on borrowing to sustain its payments during and since the Great Recession. The fund finally worked its way out of debt just last month and, as of May, posted its first positive balance since 2008.

The status of California’s unemployment trust fund has triggered calls for reform from the business community. In terms of best practices, officials need look no further than the states with well-funded unemployment insurance funds, such as Hawaii, Utah and Washington state. These states use an unemployment insurance tax base based on the average annual wage in the state. “That’s a very important feature for solvency,” says the Upjohn Institute’s O’Leary.

When the next recession comes, state funds like these will likely make it through without a hiccup. But for the others, O’Leary says, "there’s been a reluctance from state legislators to deal with this problem. In many places, they’ve paid off their debt from the last recession, but that won’t keep them from falling off a cliff again.”

Liz Farmer is a former GOVERNING fiscal policy writer.
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