The U.S. Department of Labor’s Unemployment Insurance program is funded through unemployment insurance taxes paid by employers and collected by the state and federal government. The taxes are part of the often-discussed payroll taxes all employers pay. Employers pay federal taxes of 6 percent on the first $7,000 in annual income earned by every employee. Employers who pay on time get a tax break at 5.4 percent.
The amount collected by each state varies as does the amount of income it is collected on—the first $7,000 to $34,000 an employee earns each year, depending on the state. States create their tax systems based on the costs needed to cover their unemployment claims. Contrary to popular belief, employees are very rarely required to pay into unemployment insurance. There are only three states—Arkansas, New Jersey and Pennsylvania—that ask employees to contribute and only in specific situations.
Similar to varying car insurance rates, state unemployment insurance rates vary for employers based on their history. The more employee claims an employer has had to pay out, the higher the tax rate. To avoid this, employers are encouraged to engage in strong human resource practices and avoid laying off employees. This offers employers an incentive for avoiding laying off workers and cutting positions.
The unemployment insurance tax money is placed into three pots: state programs, extended benefits program and the loan fund. The U.S. Department of Labor oversees all of the funds, which are administered through the states. The majority of the money is funneled into the state programs budgets to administer the programs in their area.
During times of increased need, such as the Great Recession, benefits may be changed on a national level using additional funds. This usually comes in the form of extending the time individuals can receive benefits over the 26 week maximum offered in most states. The loan fund is reserved for bridging gaps for states that run out of unemployment insurance money during times of heightened unemployment. State’s who borrow from this pot of money are responsible for paying it back.
As you can see, the Unemployment Insurance program operates similarly to other insurance programs—money is set aside and reserved for times of need. During greater times of the need, the system has adapted to continue fulfilling its mission of bridging the gap in income for out of work individuals.