UNEMPLOYMENT INSURANCE. A program that pays benefits to partially offset the loss of wages due to unemployment.
At the height of the Great Depression, President Franklin D. Roosevelt's Committee on Economic Security recommended the establishment of two national social insurance systems. The first program would provide old-age benefits to retired workers and the second program would provide compensation for the unemployed. In 1935, the Social Security Act created both of these programs -- the social security and unemployment insurance (UI) programs.
From its inception, the intent was to entice states to participate in UI so it would be a federal-state relationship. By 1937, all states had adopted unemployment insurance laws patterned after model legislation prepared by the Social Security Board. The board, whose formation had been recommended by the President's Committee on Economic Security, had the responsibility of assisting states in setting up their UI systems and monitoring changes in state UI systems.
The Social Security Act of 1935 contained two titles that dealt with unemployment insurance-Title III, which provided for administrative grants, and Title IX, which provided for the financing of the system. The federal administrative grants, under Title III. were to assist in the proper administration of the federal UI law among the states and were at the discretion of the Social Security Board.
Under Title IX, employers were required to pay a federal unemployment insurance excise tax if they employed eight or more people for 20 or more weeks a year. The tax rate initially was set at 1 percent of total payroll in 1936, increasing to 2 percent in 1937 and 3 percent in 1938. Some kinds of employment were excluded from the tax, such as agricultural labor, domestic employees; individuals providing service for nonprofit organizations of a religious, charitable, scientific, literary, or educational nature; and individuals working for the federal, state, and local levels of government.
As an incentive to get states to levy their own UI excise taxes, employers making contributions to state unemployment compensation programs were eligible for credit up to 90 percent of the federal tax. The credit was contingent on the state UI law conforming to federal guidelines established by the Social Security Board.
A trust fund was created by the 1935 act (see trustfund). The Unemployment Trust Fund was to receive the UI excise taxes collected by the federal and state governments and to invest the funds in federal securities.
The UI system was created with a number of objectives in mind. First and foremost, unemployment insurance was intended to alleviate the hardships that result from the loss of income during periods of unemployment. Unemployment insurance would provide cash to enable workers basically to maintain their living standard. Secondary objectives included allowing an unemployed worker time to locate new employment or regain old employment, providing the unemployed time to retrain for a new job and providing a degree of stabilization during difficult economic times.
The UI system is structured to systematically accumulate funds during good economic times in order to provide benefits during periods of high unemployment. Therefore, the concepts of solvency and reserves are of utmost importance to the successful operation of a UI system.
State unemployment insurance systems seek to balance benefit payments to recipients with contributions to the system. The traditional principle holds that the pool of reserves should be structured so it is able to finance unemployment benefits during a succession of economic cycles without going into the red. A system is considered insolvent when it lacks sufficient resources-accumulated reserves from prior periods plus employer contributions during the current period-to pay benefits earned during the period. Insolvency does not mean benefits go unpaid because the federal-state UI structure allows states to borrow from the federal unemployment trust fund to cover payments when insolvency occurs.
There are three primary approaches that can be used to maintain solvency in a state unemployment insurance system: countercyclical, replenishment, and balancing reserves. The three approaches differ in the requirements they place on reserve fund levels held in the state system and the effect they have on UI tax rate changes over time.
Countercyclical Finance. One of the stated objectives of the UI system is to provide a measure of countercyclical stabilization to counter swings in the business cycle. The system operates as an automatic stabilizer; as unemployment increases, tax contributions decline and benefit payments increase, providing a dampening effect on the decline of economic activity. In an expansion, the reverse occurs, constraining potential inflationary pressures.
In order to maximize the countercyclical potential of an unemployment insurance system, the tax rate schedule would rise when benefit payment requirements are low