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Overdue: Why California needs to reform unemployment insurance funding

Key Takeaways

  • After failing to modernize the funding since 1982, California's unemployment insurance system entered the pandemic with few reserves and ended with $20 billion in debt, the highest of any state in per-capita terms.

  • The current regressive tax structure imposes higher costs on low-wage workers and small businesses, slows hiring, and undercuts California's push toward responsible budgeting.

  • The broader the taxable wage base, the lower tax rates can be to sustainably fund the system.

Unemployment insurance (UI) is the largest self-funded economic stabilization system in the nation, helping millions of workers after they are laid off. During the pandemic, the federal Coronavirus Aid, Relief and Economic Security (CARES) Act pumped billions of dollars into state coffers to help fund the safety net. Even with the federal aid covering most of the program during the past two years, California still had UI debts of almost $20 billion at the beginning of 2022, almost half of the total borrowing by all states. Given California’s outdated unemployment insurance funding system, repaying this debt will be painful for employers and workers and will undercut the state’s efforts to responsibly budget.

How unemployment insurance works

One week after a layoff, workers are eligible for unemployment insurance benefits of up to 50 percent of their previous wages, with a maximum benefit of $450 per week in California. Workers are not eligible if they quit or are fired for cause. However, as long as they are actively searching, available, and able to work, they can usually receive UI benefits for up to 26 weeks. Benefits are deliberately set at half of usual wages to encourage workers to actively search and accept jobs. Laid-off workers can also become eligible for other safety net programs such as food stamps or Medicaid.

During recessions, many people may be laid off at once. Knowing that it may take a while to find a job, workers may rationally cut back on spending as much as possible. Businesses that used to depend on that spending may be forced to lay off more workers, making the recession worse for everyone.

Unemployment insurance benefits help cushion the overall economic blow by helping workers to pay their bills. Because UI benefits are given out to more workers during recessions while tax revenues necessarily decline, the program often runs a deficit during and after recessions. If a state does not have sufficient reserves built up in advance in its unemployment insurance trust fund, it can ultimately borrow from the federal government.

While states have the flexibility to set benefit levels and taxes on employers to fund their unemployment insurance over time, the federal government has put in place guardrails to ensure that each state’s system remains self-funded.

States have been required to assess employer taxes on the first $7,000 of wages per employee since 1982, although every state except California and three others (Arizona, Florida, and Tennessee) have updated their taxable wage caps. That $7,000 was the equivalent of full-time wages at the federal minimum wage in 1982, but now represents less than 3 months of full-time work at the minimum wage in 2022 in California.

Most states, including California, assess higher rates on employers that have a history of more frequent layoffs — called experience rating — to encourage employers to maintain their payrolls during temporary slow periods. The federal government also assesses taxes of up to 6.0 percent on the first $7,000 of annual wages per employee. When the state is able to cover benefit payments without federal borrowing, the federal tax portion is only 0.6 percent for program administration. If a state has a loan balance for more than two consecutive years (measured as of Jan. 1), the rate begins to escalate up to the full 6.0 percent until the loan is repaid. Employer taxes cannot be used to pay the interest costs on the borrowing, and states are required to cover those from general tax revenues.

California has budgeted approximately $450 million to pay its UI program’s interest costs in 2022-23 and these costs are likely to increase if — as is widely expected — interest rates rise in the months ahead.

Recent history

When the pandemic first hit more than two years ago, the federal government acted quickly to expand unemployment benefits to supplement the usual system. As a result, California’s workers received an additional $146 billion in UI benefits in 2020 and 2021 (Legislative Analyst’s Office, 2022).

Given the public health imperative, the state funded the first week of UI benefits rather than making workers wait (as is typical). Using the additional federal funding, the state was able to raise benefit levels by $600 per week across the board.

The state also expanded eligibility to independent contractors who would not ordinarily have qualified for UI benefits, since they had no employer to pay into the system. California also expanded eligibility to workers without a sufficient work history to protect new hires. The state additionally extended the maximum amount of time a worker could claim UI benefits by 13 weeks. In recognition of the disruptions to families and public health concerns, California waived the requirement that unemployed workers be actively job searching. The federal government provided money directly to employers to maintain their payrolls and encouraged states to suspend experience rating penalties for layoffs.

The federal government fully paid for expanded UI benefits, but states were still liable for basic benefits; in California that totaled $35 billion. California was one of 23 states that borrowed from the federal government during the past two years. The other 27 states were able to pay benefits with their accumulated reserves, which were built up during years of low unemployment. More than half of the 23 borrowing states quickly paid off their loans and, as of March 2022, only 9 states still had outstanding balances.[1] California's balance was $19.7 billion, or approximately half of the $40.4 billion in total state borrowing.

After the 2008 recession, California borrowed just over $10 billion, which took until 2018 to repay. In 2019, with the unemployment rate at a record-low 4.2 percent, California paid out $5.1 billion in unemployment insurance benefits and collected $5.6 billion in employer taxes. The state entered the pandemic with reserves of close to $3 billion and was, according to a January 2020 report by the U.S. Department of Labor, the least adequately funded of all 52 UI programs (including Washington, D.C., and Puerto Rico).

Not surprisingly, California’s reserves were quickly depleted, and the state began borrowing in 2020. Because the state had a negative balance (reflecting its borrowing from the federal government) on Jan. 1, 2021, and Jan. 1, 2022, employers will begin paying higher federal unemployment insurance taxes to repay those loans starting in 2023. Those taxes will continue escalating until repaid, with California's General Fund paying interest costs on the loans.

These expenses will potentially crowd out other priorities such as education and health care.

California’s Legislative Analyst’s Office (LAO) estimates that if interest rates only rise to about 2.5 percent during the next two or three years, the state will pay about $3 billion in interest costs until the loan is repaid in 2030. Given increasing inflation, it is increasingly likely that the Federal Reserve will have to increase interest rates.

If interest rates were higher at 4.5 percent, the state would have to pay interest costs of more than $7 billion, with full repayment delayed until 2032. The $3 billion in early repayments proposed in Gov. Gavin Newsom’s budget for the 2023 fiscal year could reduce the repayment time by one year. However, the tax base would still be far too narrow to build up reserves, and the next recession would cause debts to again increase, with the problem becoming more severe over time as a smaller and smaller fraction of wages in the state is subject to UI taxes.

Looking Ahead at State Costs to Repay the Federal UI Loan

LAO Projections (In Millions)

Fiscal Year

Estimated State Interest Payment

Low‑Cost Scenario

High‑Cost Scenario






































Note: low‑cost scenario assumes 2.5 percent interest rate, whereas high‑cost scenario assumes 4.5 percent interest rate.

UI = Unemployment Insurance.

Higher unemployment rates mean more people claiming benefits and fewer employers paying into the system. In January of 2022, the unemployment rate was 5.8 percent in California (second highest in the nation behind New Mexico), but 4 percent for the nation as a whole. This relatively higher unemployment rate extends the repayment period, forcing the remaining employers to face escalating tax rates. These escalating taxes over a longer period are not good for employers or for employees.

Duggan, Guo, and Johnston (2022) found that these higher UI tax rates (necessitated by low tax bases as in California) discourage hiring, particularly of part-time and low-wage workers. These are the workers who likely have few savings and qualify for lower benefit levels, making unemployment even harder to weather. The necessarily higher employer taxes on these lower-wage workers also lead to lower wages for them.

Put simply, employers pay their low-wage workers less when their UI costs of these same workers are higher. Researchers at the U.S. Census Bureau also found that lower-wage workers tend disproportionately to hold multiple jobs to make ends meet (Bailey and Spletzer, 2021). Taxable wages of $7,000 represent less than 3 months of full-time minimum wage work in California, or less than 6 months of half-time minimum wage work. A lower-wage worker with several jobs could effectively have employers paying into the system multiple times, but would not receive correspondingly higher benefits. The limited tax base makes UI benefits inequitable since higher-income laid-off workers receive more benefits than their low-income counterparts despite the same cost to employers.

In addition to penalizing employers and workers, the limited UI tax base prevents the advance accumulation of reserves, undercutting California's attempts to save during good times to cushion spending during tough economic times.

California voters approved the creation of a rainy day fund in 2014 in recognition of volatile revenues. Up to 10 percent of the General Fund can be saved, with California putting away more than $20 billion before the pandemic. This was accomplished by forgoing spending, despite many proposals that would have helped residents and businesses, so that cuts to essential services could be avoided when revenues fell.

Revenues typically fall during recessions, when layoffs are highest and California tends to borrow to pay unemployment insurance benefits. Interest payments from the General Fund to service unemployment insurance debts cut into other spending priorities and also cut into the rainy day fund. This is an inefficient way to fund the system.

Because updating the taxable wage cap would require a two-thirds vote in the California State Legislature, and the cap has not been updated for 40 years, any change would ideally be indexed to adjust automatically to changing economic conditions in the future. The larger the taxable wage base, the lower tax rates can be to raise the same amount of money, as illustrated below. The calculations assume the state would need to raise roughly $10 billion annually to build up adequate reserves in advance.

The current system in California has an annual taxable wage cap of $7,000, state tax rates of up to 6.2 percent, with adjustments for past layoffs through experience rating. UI revenues of $5.6 billion on 17.4 million jobs in 2019 imply an average tax rate of 4.5 percent (of the $7,000 base) in that same year (when unemployment was historically low). Raising $10 billion on that same base would imply an average tax rate of more than 8 percent.

Opportunities for reform

California policymakers have several ways to shore up the state’s UI funding. One option would be to have a tax base that corresponds to the full-time minimum wage. This would represent a taxable wage base of $31,200 in 2023. Assuming 17 million jobs contribute (not all jobs are full-time), the state could raise $10 billion at an average tax rate of only about 2 percent. The advantage of indexing taxable wages to the minimum wage or to average wages would be the automatic adjustments over time (as exists in Washington and Oregon). It would also avoid the additional contributions for minimum wage workers who have multiple part-time jobs or switch jobs during the year.

An arguably even better alternative would be to tax covered wages: Benefits are capped at $450 a week for workers earning up to $900 a week. Beyond earnings of $900 per week, the UI program does not provide insurance. The annual equivalent would be $46,800 ($900 per week). Assuming 15 million jobs contributing (to adjust for the fact that some jobs would pay less than $46,800 annually), an average tax rate of 1.5 percent could raise $10 billion. This would bring California closer to the nation-leading levels of $62,500 annually in Washington state[2] or Oregon’s base of $47,700.[3]

Finally, removing the cap on earnings subject to UI taxes would allow for the lowest tax rates on employers. No state uncaps taxable wages for the payment of unemployment insurance taxes. Of the other self-funding programs, only the Medicare program taxes all wages.[4] The California Department of Finance projects that total wages and salaries will reach $1.7 trillion in 2023. To raise $10 billion, an average tax rate of just under 0.6 percent would be needed. Revenues would automatically adjust along with inflation, and this would be much more progressive since higher-income workers who earn a disproportionate share of total wages would contribute far more than their expected unemployment insurance benefits (they also face fewer layoffs since the probability of layoff declines with income).

It is important to emphasize that an increase in the UI tax base would represent a redistribution of the tax burden rather than an overall increase in taxes. At present, low-income workers in California pay a disproportionate share of UI taxes relative to in other states. It is difficult to justify a system in which employers pay the same UI tax for low-income workers as for high-income workers and yet the latter group receives a higher benefit following layoff.[5] California does however need to generate more revenues for its UI program given its peculiarly low tax base along with its relatively high unemployment, which has consistently exceeded the national average for the last 30 years as shown in the figure below.

U.S. and California Unemployment Rates Figure

Lessons learned

While the federal government acted quickly to bolster the states’ UI systems during the pandemic, California cannot continue relying on this assistance. An increase in the UI tax base would lower the cost to employers of hiring the most vulnerable workers and would lead to more employment opportunities and higher wages for them.

The pandemic also showed the pressing need to modernize administration of the system to better stabilize our economy, but better administration will not fix the underlying funding imbalance. For that, additional funding is needed, and the balancing act between tax rates and the taxable wage base is clear.

The past few years have shown that California's current unemployment insurance funding system does not serve employers, workers, or our economy well. After 40 years of keeping our UI tax base at $7,000 while average wages in the state approximately quadrupled, it is time for an update to the level of the tax base and to index this base to help funding levels automatically adjust along with the economy.

Rarely does a state have the opportunity to simultaneously improve both the equity and the efficiency of economic policy with the move of one policy lever. But that is the case with California’s unemployment insurance tax base. California’s policymakers can help workers, employers, along with both current and future taxpayers by expanding the UI tax base.

Irena Asmundson is a SIEPR research scholar and the managing director and policy fellow of the California Policy Research Initiative (CAPRI). She has served as the chief economist and program budget manager for the forecasting unit at the California Department of Finance.

Mark Duggan is the Trione Director of SIEPR and the Wayne and Jodi Cooperman Professor of Economics. His research focuses on the health care sector and the effects of government expenditure programs.

Carolyn Minh-Thi Ky, a SIEPR research assistant, provided invaluable research support for this policy brief.


[1] The eight other states with UI debt are Colorado, Connecticut, Illinois, Massachusetts, Minnesota, New Jersey, New York, and Pennsylvania.  Their combined debt of $20.7 billion is only slightly higher than California’s $19.7 billion in UI debt. Data accessed March 19, 2022:

[2] Washington State Employment Security Department,

[4] Until 1991 Medicare used the same tax base as Social Security and it then became uncapped in 1994.

[5] Consider an employer in California with two workers – one who earns just $7,500 annually and the other earns $45,000 annually. The UI tax cost to the employer is the same for the two workers. However, the latter worker would receive a weekly UI benefit that is six times higher than the low-income worker.


Bailey, Keith A. and James R. Spletzer. “A New Measure of Multiple Job-holding in the U.S. Economy.” Labour Economics, August 2021, Volume 71.

Duggan, Mark, Audrey Guo, and Andrew Johnston. “Would Broadening the UI Tax Base Help Low-Income Workers?” forthcoming in American Economic Review Papers and Proceedings. 2022


Irena Asmundson
Mark Duggan
Publication Date
March, 2022