Cut Payroll Tax Now: Use State Reserve, Not UI, for Community Colleges

1. Years of inept management of the state’s UI system during the 1980s and early 1990s left its trust fund in Washington massively overfunded. This had the result of subsidizing new and seasonal industries at the expense of longtime businesses, maintaining unnecessarily high combined tax rates on payroll and income earned in North Carolina, and imposing a significant “opportunity cost” on the state’s economy as hundreds of millions of dollars sat in federal accounts in Washington (helping to offset the federal budget deficit) rather than circulating within North Carolina in the form of higher wages, lower prices, or higher investment returns.

   After an early stab at UI tax reduction in 1987, when the state’s UI account in Washington stood at $1.1 billion, the General Assembly began to take the UI overcharging problem seriously in 1993, when the trust fund had reached $1.6 billion (now including a separate, state-controlled UI reserve of $200 million). The legislature passed a 30 percent tax reduction in 1993, a 39 percent reduction in 1994, and a 23 percent reduction in 1995. The trust fund continued to exceed necessary levels. In 1996, the legislature, still faced with a massive combined fund of $1.7 billion, came up with a partial moratorium on UI taxes, excluding many employers with positive credit balances.1

   Current Situation

   Unfortunately, the problem persists. As of June 1, 1999, the state’s trust fund in Washington contained $1.3 billion.2 The separate state reserve of $200 million was also intact. After six years of tinkering, the combined balance had fallen to $1.5 billion from $1.6 billion. It is still far more than will ever be needed for jobless claims. And it is a huge amount of money not being put to productive use in the private economy.

   Earlier this year, there was some talk of further UI tax cuts. Unfortunately, the talk has resulted in a bill (House Bill 275) already passed by the Senate and currently in House committee that would cut the UI payroll tax by 20 percent — representing about $28 million in FY 1999-00 and $72 million by FY 2000-01 — but replace it nearly dollar-for-dollar with a new state tax to fund community college training programs and Employment Security Commission (ESC) administration.3

   While possibly a good-faith attempt to reclaim state funds sitting in federal accounts, the new approach does not fundamentally reform the UI system. Nor would it be a wise use of taxpayer dollars. The new tax revenue would be split among community college equipment and technology ($42.5 million); low- or no-cost industry training programs ($12 million); cooperative programs between colleges, universities, and public schools ($2 million); and ESC administrative and reemployment costs ($14.1 million). Only the community college infrastructure needs could qualify as high priorities. The $12 million for training represents an expansion of the state’s already generous system for subsidizing corporate relocations and expansions. And the compensation for higher ESC administrative costs is truly puzzling — there is no real change in the payroll tax rate, just changes in where the collected revenues are flowing. Little additional administrative cost is required.

   An Alternative Approach

   There is another way to reform the state’s mismanaged UI system without imposing new taxes or funding more corporate welfare. It consists of three steps:

   1. Cut UI Payroll Taxes Now

      The trust fund remains far too large. The state should apply at least the 20 percent cut in UI tax rates included in House Bill 275. The federal trust fund of $1.3 billion should be reduced significantly through tax cuts or rebates until it includes only enough money to provide a reasonable cushion should a recession depress tax collections and increase benefit payments.

   2. Draw Down the State Reserve Fund

      North Carolina did not need to create its own $200 million UI reserve account in the late 1980s. Indeed, it did so even as its federal UI account was overfunded. If community colleges require new equipment and technology to meet their educational mission, drawing down the state reserve account would be a more appropriate funding vehicle than levying a new state tax. Withdrawing $25 million a year would provide a funding stream for college improvements for at least eight years.

   3. Petition the Federal Government for Complete Devolution

      In the long run, North Carolina should demand control of its own UI system to meet the needs of its workers and employers more efficiently. Devolution would reduce needless administrative expenses and give the state the authority to pursue other models. One such model, outlined in a 1998 Locke Foundation policy report, would convert part of the UI tax into direct deposits to personal savings accounts owned by workers. These funds could be tapped in the event of a layoff, career change, entrepreneurship, or to go back to school. The rest of the payroll tax could be used to purchase private job-search services should workers need assistance finding a new job.4

Don Carrington, Vice President

Notes

1. Don Carrington and Jonathan Jordan, Savings & Loans: Reforming Unemployment Insurance Through Competition and Compound Interest, Policy Report No. 21, John Locke Foundation, April 1998, pp. 14-15.
2. North Carolina fund balance obtained by phone from U.S. Department of Labor, June 2, 1999.
3. Richard Bostic and Dave Crotts, Legislative Fiscal Estimate, House Bill 275 (Third Edition), May 27, 1999, pp. 1-2.
4. See Carrington and Jordan, pp. 21-31.