Budget Basics: Unemployment Insurance Explained

Unemployment insurance (UI) is a joint state-federal program that was established in 1935 to provide temporary financial assistance to workers who become unemployed by no fault of their own. Each state administers its own UI program, but all states follow some basic federal guidelines. The program is a critical part of the country’s safety net, operating as an automatic stabilizer so that it kicks in when needed, but also may be adjusted to provide enhanced support to Americans during severe economic downturns.

Who Is Eligible for Unemployment Insurance?

To qualify for unemployment insurance benefits, a person must generally:

• have lost a job through no fault of their own — for example, because of layoffs, downsizing, or lack of available work;
• be “able to work, available to work, and actively seeking work”; and
• have earned at least $2,900 in one of the calendar quarters during a “base period” prior to becoming unemployed.

In the last 20 years, seasonally-adjusted weekly initial claims (the number of new applications filed for unemployment insurance) have averaged around 363,000, excluding recessions; by comparison, initial claims spiked to the highest amount in history at 6.1 million claims during the pandemic. However, claims have reverted back to more typical numbers; the week ending September 17, 2022, saw 213,000 initial claims.

Continuing claims, which are not seasonally-adjusted and measure the total number of workers collecting benefits, averaged 5.2 million over the last 20 years, excluding recessions. At the peak of the pandemic, there were 33.2 million continuing claims. Continuing claims have declined since the pandemic and are at the lower end of historic values at 1.3 million claims during the week ending September 3, 2022.

Generally, payments are based on a percentage of an individual’s earnings over a 52-week period and last for a maximum of 26 weeks in most states. However, the duration of payments can vary because each state legislature has discretion over additional requirements for eligibility, benefit amounts, and duration of payments. For example, Florida provides benefits for up to 12 weeks, whereas Massachusetts provides them for up to 30 weeks. The Extended Benefits program — the funding of which is split evenly by the federal government and the states — may be triggered in a state with a period of high unemployment and provides an additional 13 or 20 weeks of compensation. Additional federal UI benefits can also be created through congressional action to further supplement payments during recessions.

Payment amounts vary greatly due to different formula calculations and costs of living in each state. The amounts dispersed are contingent on how much of an individual’s income each state chooses to replace. That parameter, called the replacement rate, ranges from 30 percent to 50 percent. Before the expansion of UI during the coronavirus (COVID-19) pandemic, national average weekly payments were $387. The lowest average weekly payment was $215 in Mississippi, and the highest was $550 in Massachusetts.

How Is the Unemployment Insurance Program Funded?

The Unemployment Trust Fund is held by the U.S. Treasury Department, but each state has its own account under the fund. The largest revenue stream comes from the State Unemployment Tax Act, which is a state tax levied on employers. In fiscal year 2021, those state revenues amounted to $46 billion and covered the cost of regular benefit payments. The secondary source of funding comes from the Federal Unemployment Tax Act (FUTA), which amounted to $6 billion in fiscal year 2021. The FUTA tax is paid by employers and it is 6 percent of the first $7,000 of each employee’s wages. However, employers who pay their state unemployment taxes on time receive an offset credit of up to 5.4 percentage points, meaning the maximum FUTA tax for an employee may be as little as $42. States can borrow funds from the federal government if they exhaust their account, but if they are overdue on repaying, then the federal taxes on employers automatically increase until the debt is paid.

Before the COVID-19 pandemic in 2019, spending on unemployment compensation totaled $30 billion, or about 0.1 percent of gross domestic product (GDP). Because of the pandemic and legislative efforts to address its economic effects, such spending in fiscal year 2020 skyrocketed to $475 billion (2.3 percent of GDP), the highest level ever recorded. The Congressional Budget Office estimates that spending will return to a more typical level this year at around $40 billion.

How COVID-19 Affected the Unemployment Insurance Program

To support the millions of Americans who lost their jobs as a result of the pandemic, three enhancements to the program were enacted:

• First, the federal government added $600 per week to state-funded unemployment benefits that lasted through July 2020, then through early September 2021 the additional amount was reduced to $300 per week.
• It also expanded eligibility to those who are usually ineligible: part-time workers, freelance workers, independent contractors, and those who are self-employed.
• Finally, it extended the duration of benefits people could be eligible for to a maximum of 53 weeks.

Roughly one in five people in the labor force (33 million) were on unemployment insurance during the week ending on June 20, 2020 — 15 million of whom were collecting benefits under the pandemic-related expansions of the program. Those temporary provisions, which were entirely funded by the federal government, expired on September 5, 2021.

Issues with the Structure of the Unemployment Insurance Program

The biggest issue raised with the UI program is the concern that individuals may be discouraged from reentering the workforce if benefits are too generous. The St. Louis Fed found that larger benefits were inversely related to the intensity of job searches. They discovered that if benefits increase by 10 percent, the time spent on job searches decreases by about 16 percent, although the intensity of searches increased as the end date of benefit payments drew closer. However, during the COVID-19 pandemic, studies showed that there was not a significant effect on overall employment from expanded benefits. During that period, the vast majority of unemployment was due to fewer available jobs.

One of the other concerns with the UI program is that it does not necessarily help those with the most need. Self-employed workers and unincorporated independent contractors who work in the gig economy are not covered by traditional UI, despite the fact that they make up about 10 percent of the nation’s total workforce. Furthermore, most states have a minimum requirement for time worked and amount of earnings in order to be eligible for benefits. A consequence of those work history requirements is that low-wage workers, who are more likely to be unemployed, are among the least likely to receive UI benefits; steady earnings are needed to qualify for benefits, and low-wage workers tend to work more intermittently. During the Great Recession, only one quarter of low-wage workers were granted unemployment insurance, whereas workers who earned more than the 30th percentile wage were twice as likely to be granted UI benefits.

There are also antiquated state systems that make administration and maintenance of the program inefficient. Because each state has different guidelines for its program, navigating the eligibility requirements and understanding the payment structure can be complex. Even in February 2021, nearly a year into the pandemic, just six states reported meeting the federal standard of providing benefits to 87 percent of applicants within three weeks. In addition, nearly 80 percent of state workforce agencies characterized their IT systems as “barely functional” or “needs improvement” even before the pandemic in 2017. Expansions of the UI program also led to a considerable amount of fraud. The Department of Labor’s Office of Inspector General estimated that more than 10 percent of pandemic-related UI benefits, $87.3 billion, will ultimately have been spent improperly, a significant portion of which is attributable to fraud.

Reform Options for Unemployment Insurance

Because of externalities resulting from different approaches to the UI program, especially those from the pandemic-related expansions, researchers and lawmakers have proposed ways in which to improve the system.

To incentivize people to return to work:

• Short-term compensation programs. Short-term compensation is a form of UI in which employees whose hours have been reduced, but remain employed, can receive a prorated portion of unemployment benefits. Given fears about traditional UI discouraging work, research from Japan and across Europe finds that short-term compensation programs can provide an incentive for workers to remain in the workforce during an economic recession.
• Individual unemployment insurance accounts. When looking at UI programs from other developed countries, some economists found that the best way to redesign a UI program is to implement decreasing payments the longer one’s unemployment persists, and after re-employment, individuals would be taxed at rates depending on their length of unemployment. Individuals who use their benefits for longer periods of time would have to contribute more after reentering the workforce in order to balance their unemployment account.

To make UI more accessible to those with the most need:

• Expand support for more types of workers. After benefits were extended to part-time workers, freelance workers, independent contractors, and those who were self-employed during the COVID-19 pandemic, there has been a push for that to be a permanent expansion of UI. Including non-traditional workers to normal UI would make the program more accessible and easier for those with greater need to receive benefits.
• Increase support for the Reemployment Services and Eligibility Assessment (RESEA) program. The President’s proposed budget for fiscal year 2023 allocates $249 million in funding for the RESEA program to provide greater access to reemployment services and help claimants assess if they are eligible for continuing benefits.

To improve antiquated systems:

• Make UI expansions during recessions an automatic stabilizer. Making UI expansions automatic during strenuous economic times would eliminate delays that can incur from trying to enact emergency legislation. It would shorten the process and get benefit payments to people quicker.
• Modernize infrastructure. The President’s proposed budget for fiscal year 2023 outlined $3.4 billion, an increase of $769 million above the 2021 enacted level, to modernize, protect, and strengthen the program. It included several investments aimed at tackling fraud through more robust identity verification, helping states develop fraud-prevention tools, and allowing the Office of Inspector General to increase its investigations into fraud rings.

Conclusion

The Unemployment Insurance program is a critical part of the safety net and a vital support system for people during difficult times, especially during recessions. It is also a key counter-cyclical tool to help stabilize the economy and speed recovery during downturns or crises. Given its importance, but also its cost within the budget, it’s important for lawmakers to continue to examine ways to make it more efficient, effective, and targeted for the future.