U.S. Labor Dept. Testimony at W&M Hearing on Employment Security Bill

STATEMENT OF GRACE A. KILBANE

June 23, 1998

[1] Mr. Chairman and Members of the Subcommittee:

[2] Thank you for the opportunity to testify on the Employment Security Financing Act of 1998 (H.R. 3684) and its impact on the unemployment insurance (UI) program. There are several significant issues that need to be considered in order to ensure that the Employment Security system fulfills its mission in today's changing economy and that it remains on sound financial footing for the 21st Century. As I will discuss below, the Administration has proposed legislation to begin to address some of these issues and initiated a broad dialogue on reform of the UI program.

[3] As you know, the bill that is the focus of today's hearing, H.R. 3684, was developed by the Coalition for Employment Security Financing Reform, essentially to address administrative funding problems. I applaud the bill's overall objective to reform the funding structure of the Employment Security system. The Department of Labor, however, has serious concerns about the proposal as well as important issues which should be addressed, but are not included in the bill.

BACKGROUND

[4] Before turning to H.R. 3684, I would like to take a moment to provide some background information on the UI program. Enacted over sixty years ago as a Federal-State partnership, UI has been a major source of temporary income support for laid-off workers who are seeking work. In addition, for over sixty years, the Employment Service (ES) program has served to assist workers in finding new jobs. Since the advent of both programs, the economy has changed, the workforce has changed, the workplace has changed and the way we work has changed, affecting both workers and businesses. Research suggests that these changes may be impacting the UI program in unanticipated ways.

[5] UI coverage has expanded so that 97 percent of all wage earners are now covered by the UI program. However, UI recipiency has been declining, which means that a lower percentage of the unemployed receive benefits. Research attributes the decline in recipiency to a number of factors. Changes in the labor market, such as geographic shifts and sectoral shifts from manufacturing to the services sector, are part of the explanation. But State law changes that restrict program eligibility and lower wage replacement rates also play a role. Declining recipiency means that the UI program has lost some of its effectiveness as an automatic economic stabilizer.

[6] Despite these declines in UI recipiency, research indicates potential financial problems in the UI system. Projections show that State borrowing during the next recession will be much higher than it was in the 1980's because of relatively lower State trust fund reserves. Now, while the economy is strong and unemployment is low, is an opportune time to reform and strengthen the UI program.

KEY ISSUES

[7] Reform is needed to strengthen the UI program in three (3) key areas: recipiency, recession readiness, and administrative funding.

[8] Recipiency -- The recipiency rate for unemployment compensation has dropped from 49% in the 1950's to an average 35% in the 1990's and is below 20% in some States. That means that the program is currently serving proportionately fewer unemployed workers than in the past. This harms the program's ability to help workers who have lost their jobs, as well as weakens its role as a stabilizer in the economy.

[9] Recession Readiness -- Recessions are experienced at the State and Regional levels and the UI program should work effectively at those levels. However, during the last recession, only nine (9) States "triggered on" to the Extended Benefit (EB) program -- the program established to provide additional benefits during periods of economic downturn. State trust fund levels, which are the amount of funds States have available to pay benefits, are also a concern. Even though we now enjoy a period of very low unemployment, estimates show that an economic downturn of the magnitude of the 1980-82 recession could result in $20-$25 BILLION of State borrowing of Federal funds to cover UI benefits.

[10] Administrative Funding -- Funding for the Employment Security system has been steadily declining. Since fiscal year (FY) 1995, the UI appropriation has remained static, ignoring the increased costs of inflation and workload growth associated with increases in the number of subject employers and growth in the civilian labor force. Consequently, activities that are needed to preserve the integrity of the Trust Fund are curtailed. These include prevention, detection, and collection of benefit overpayments, as well as tax audits and collections of delinquencies. The reduction of these activities costs the Trust Fund approximately $160 million per year.

[11] The Employment Service (ES) has also experienced steady cuts in funding. Since 1984, when adjusted for inflation, Wagner- Peyser grants to States to provide job finding and placement services to UI claimants and other job seekers have been reduced substantially. Among other impacts, this affects services to help unemployed workers return to work quickly, contributing to a higher average duration of unemployment (14.8 weeks) during this good economy and to a higher rate of exhaustion (33%) of benefits than is typical at this stage of the economic cycle. The Administration's approach has been to increase funding to the system through one-stop grants. States have attempted to compensate for the under-funding by supplementing Federal funding of the Employment Security system with approximately $200 million in FY 1997, about $89 million for UI and approximately $111 million for ES.

[12] These issues and program trends indicate that it is time to address both funding and program reform to ensure that the fundamental principles of the UI program are met.

UI PRINCIPLES

[13] The major components of the UI program involve payment of benefits, funding of benefits, and administration of the program. Accordingly, a fundamental principle of the UI program is that benefits should provide an adequate economic cushion while recipients search for suitable work. For the program to provide macroeconomic stabilization, these benefits must be available to a sufficiently large portion of workers who lose their jobs.

[14] A basic benefit funding principle is that the UI program be self-financing. This means that funds should be accumulated during periods of economic growth so that they will be available to pay benefits during economic downturns. This self-financing principle also has a Federal component. Federal UI taxes build up balances to pay the Federal share (50%) of the EB program and to provide repayable advances to States that have become insolvent. In both cases, Federal funds are available to all States without regard to how much Federal tax the employers in a State have paid.

[15] In terms of program administration, States and the Department of Labor share responsibilities. Each State operates its UI program in accordance with its law, but State law is required to conform with certain basic provisions of Federal law. Administrative funding for the UI program and 97 percent of funding for ES programs comes from Federal UI taxes. Congress appropriates administrative funds which are allocated based on individual State needs without regard to the amount of taxes paid by the employers in a State. Federal UI taxes also pay Federal administrative costs.

COMMENTS ON H.R. 3684

[16] I would like to turn to our concerns with H.R. 3684. The stated primary purpose of the bill is to remedy insufficient funding of Employment Security programs by Congress. I certainly agree that the States should be fully funded to provide adequate services to job seekers and employers. The solution proposed -- transferring the funding from Congress to the States -- does not guarantee full funding, however. Transferring the appropriation authority from one body to 53 legislative bodies does not, by itself, provide full funding and may exacerbate the problem. This is of special concern for both the Veterans' Employment and Training (VETS) program, which relies on these funds to provide special veterans' employment services, and the UI program regarding workload funding. Most State legislatures meet for only a portion of a year and six meet on a biennial schedule. This makes it difficult for States to respond quickly to changes in workload caused by an unforeseen economic downturn (or even unemployment caused by a large natural disaster) and could cause serious funding shortages at a time when they can least be afforded. In addition, this approach undermines the insurance principle of the program that funds are to be pooled into a unified account and distributed based on workload -- not on taxes paid.

[17] The bill would also transfer the responsibility for collecting Federal Unemployment Tax Act taxes, known as FUTA taxes, from the Internal Revenue Service to the States, effective calendar year 2000. The tax would remain a Federal tax, with the States acting as agents for the Treasury Department on a contractual basis. We do not believe that having States collect Federal revenue and having their legislatures appropriate Federal dollars with no required guidelines or standards is the best option for funding administration of these programs. The absence of guidelines and standards would seem to run counter to the Congressional emphasis on performance in the Governmental Performance and Results Act (GPRA). The Department's UI dialogue has begun to identify a variety of alternative approaches to address the administrative funding issue such as: switching the funding to the mandatory side of the budget; creating a permanent adjustment of the caps on the discretionary side of the budget to accommodate the changing needs of the Employment Security system; or if the States are to be responsible for administrative funding, combining State UI-ES administrative tax with the State benefit tax, reducing but maintaining the FUTA tax for Federal purposes. Each of these alternatives has advantages and disadvantages, and we expect further examination of these and other alternatives through the UI dialogue.

[18] The bill calls for a wholesale restructuring of the Unemployment Trust Fund, effectively breaking the current Employment Security Administration Account into 53 State accounts. A new Federal administration account would be established for the Secretary of Labor, with funding limited to 2% of FUTA collections. This would be $70 million less than the current funding level of approximately $195 million (a 36% cut) for Federal administration of UI, ES, VETS and Bureau of Labor Statistics (BLS) oversight, and funds for State collection of labor market information. If the Secretary's obligations remain substantially the same, this option would not allow the Department of Labor to continue to administer the programs responsibly. Furthermore, it is unclear whether the bill would maintain the current arrangements for carrying out cooperative statistical programs through the BLS since, in addition to the funding reduction, the bill appears to authorize these activities separately at the Federal and State account levels. Any such restructuring of the UI Trust Fund appropriation to the BLS could effectively terminate or radically change the National Labor Market Information program. The current trust fund arrangement supports the production of some the Nation's most important economic indicators of employment and unemployment. This includes, among others, the Current Employment Statistics survey which is designed to provide industry information on employment, hours, and earnings data used to produce the monthly Employment Situation Report for the Nation, States, and metropolitan areas.

[19] The Extended Unemployment Compensation Account, the current source of funds for the Federal share of EB, would be eliminated by the bill, as would the Federal partnership in the program. The EB program, established to provide additional benefits during periods of economic downturn, would be funded and administered independently by each State. There would be no special funding mechanism for these benefits. Since the proposal would not reform the EB program, Congress could be faced with enacting special emergency unemployment compensation (EUC) in the event of an economic downturn. In the last recession, the Federal EUC costs were $28.5 billion -- of this amount, $12 billion were funded by FUTA and $16.5 billion were funded by general revenues. The FUTA funding would no longer be available to Congress.

[20] Lastly, the proposal weakens State accountability by requiring States to individually determine performance and report to their Governors. The proposal still requires the Secretary of Labor to review and certify that States' laws conform and activities substantially comply with Federal requirements. Because the bill removes State administrative funding from the Federal government, there are no sanctions that can be imposed on State governments for noncompliance. Only the employers of a noncompliant State would suffer any consequences if a State failed to meet the requirements of the law. Failure of a State to meet the requirements for certification would result in a loss of credit against the Federal tax for employers in the State. This would place a State in the peculiar situation of charging employers a higher Federal tax -- 6.2% (6% after 2004) rather than 0.8% -- for a condition that the State itself caused. In the spirit of GPRA, Federal performance standards should be considered to ensure that a viable national economic security system is in place for the country while providing States flexibility to tailor the programs to their individual economies.

[21] In summary, I agree that the administrative funding mechanism for the Employment Security program is in need of repair. However, I do not believe that transferring funding from Congress to the States achieves full funding or other necessary reforms of the program. We believe a reform bill should also address the most fundamental principle of the UI program, that is the assurance of adequate benefits for a sufficiently large number of job seekers. For instance, the recipiency rate for unemployment compensation is not addressed in the bill. In addition, a reform bill should address trust fund solvency goals and bolster the EB program -- elements that are essential to assure that the program responds adequately to economic downturns.

THE ADMINISTRATION'S APPROACH TO REFORM

[22] With the issuance of the President's FY 1999 budget request, the Administration set in motion a reform of the Employment Security system. Due to the complexities inherent in a major reform effort, the Administration is pursuing a two-phase strategy. The first phase is comprised of a legislative, as well as an appropriations component. The funds requested in the FY 1999 budget are designed to provide full-funding for the UI program, while a long-term solution to the administrative funding problem is developed.

[23] The Administration has also proposed legislation, H.R. 3697, introduced on a bipartisan basis by Representatives Levin, English and Rangel, that represents an important step toward addressing the issues confronting the Employment Security system. This bill would provide incentives to strengthen the UI program in the areas of recipiency, recession readiness, and administrative funding and is a "down payment" toward more comprehensive reform. The major components of H.R. 3697 are:

[24] Recipiency -- H.R. 3697 provides incentives to States to voluntarily implement administrative systems that will make the program more accessible to low-wage workers. In each of fiscal years 1999, 2000, and 2001, $20 million will be available to reimburse costs to States to implement alternative base periods. An estimated additional 450,000 low-wage unemployed workers could be helped annually if all States adopted an alternative base period.

[25] Recession Readiness -- The Administration's bill would enhance the Federal-State Extended Benefit program by revising program triggers to make the program more responsive during a recession. H.R. 3697 also provides an incentive -- in the form of a Reed Act distribution -- to encourage States to voluntarily improve the solvency of their unemployment trust funds accounts. Currently, 22 States have reserves below the target level recommended by the Advisory Council on Unemployment Compensation as necessary to ensure States have sufficient funds to pay benefits during periods of high unemployment. Inadequate trust fund account balances could cause States to take actions such as increasing taxes, reducing benefits, or taking out interest bearing loans in the next recession as some have been compelled to do in the past.

[26] Administrative Funding -- The bill proposes the installation of a temporary mechanism to strengthen State funding for administration of the UI program through a special distribution to fill the funding gaps between the calculated need and the appropriated amount resulting in full funding for FY 1999-2003. This is a temporary "fix" only. A long-term solution is needed for the under-funding problem, and this will be focused on in the upcoming dialogue.

[27] In addition, H.R. 3697 proposes to extend for ten years the Self-Employment Assistance (SEA) Program, which is due to expire December 8. SEA -- which gives greater flexibility to UI claimants by allowing them to receive unemployment compensation while becoming self-employed -- has been adopted by ten States and has proven to be a useful tool for States to assist certain unemployed workers create their own jobs by starting small businesses.

[28] The second phase is a national dialogue which will engage all interested parties -- including Congress, workers, employers, State governments and Federal agencies -- in an effort to work through a broad range of issues. The following questions will be discussed:

o how well is the Employment Security system fostering

o how well is it serving as a macroeconomic stabilizer,

o is the financing structure financially sound in terms of

o how well is the benefit financing structure working with

o how well does the administrative funding component work?

[29] The UI program is an American success story -- working efficiently in good times and bad, as it helps millions of workers annually. We need to be sure we are on the right track to maintain this successful program and strengthen the nation's economic infrastructure in the coming millennium. Therefore, during the coming months, the Administration will hold public hearings, and meet with interested parties across the nation to receive input toward the resolution of these issues.

[30] This concludes my formal remarks. I appreciate the opportunity afforded me to speak to the subcommittee and look forward to working with you, the States, and all other stakeholders who share with the Department of Labor the ultimate goal of reforming and strengthening the UI program.