The Heritage Foundation

Backgrounder #1213

August 14, 1998

August 14, 1998 | Backgrounder on

How Congress Can Lower The Cost of American Jobs

As Congress considers ways to return the budget surplus to taxpayers, a good first step would be to look at the payroll tax increase it imposed on workers last year.

The third largest tax increase in the Taxpayer Relief Act of 1997 was an extension of a little-known payroll surtax in the Federal Unemployment Tax Act (FUTA) that was scheduled to expire at the end of 1998. Believing incorrectly that they needed to increase revenues to balance the budget, Members voted to extend the FUTA surtax through 2007 and raised the ceiling on federal trust funds. As a result, the tax burden on American workers has hit an all-time high, and surplus unemployment taxes pile up to be used for purposes completely unrelated to the unemployment system.

Revenue from the FUTA tax is designated for the administration of the Unemployment Insurance (UI) system. The current FUTA tax rate of 0.8 percent on the first $7,000 of wages has two components: a permanent tax rate of 0.6 percent and a temporary surtax of 0.2 percent. Passed in 1976 to restore depleted federal UI trust funds, the surtax was set to expire in 1987. Since 1987, however, it has been extended five times--despite having accomplished its goal--and is now set to expire at the end of 2007.

This repeated extension of a supposedly temporary surtax has caused federal UI trust fund balances to balloon from $4.9 billion in 1987 to $19.1 billion in 1997.1 Because of last year's extension of the surtax, trust fund balances are forecast to explode to $41.6 billion at the end of fiscal year (FY) 2003 (see Chart 1).2 Like Social Security payroll tax revenue, FUTA surtax revenue in federal trust funds is converted to federal government bonds and spent as general revenues; the money is not set aside for the UI system.

Senator Wayne Allard (R-CO) has introduced legislation (S. 2170) to repeal the FUTA surtax. Representative Clay Shaw (R-FL) has introduced the Employment Security Financing Act of 1998 (H.R. 3684), which would not only repeal the surtax, but also significantly reform how the Employment Security system is financed.

Together, these two bills would let workers and businesses keep $8.1 billion more of their hard-earned money over the next five years--just 1.6 percent of the projected budget surplus.3 They also would let Congress honor the promise it made in 1993 to repeal the temporary FUTA surtax, and take a small step toward lowering the tax burden on American jobs.4

BENEFITS OF ENDING THE FUTA SURTAX

There are three important benefits to ending the FUTA surtax:

  • It would stop the unnecessary overtaxation of jobs. In 1998, the federal tax burden is expected to reach a record peacetime high of nearly 21 percent of economic output.5 In FY 1997, only $3.5 billion (57 percent) of $6.1 billion in FUTA tax collection was returned in federal grants to administer state unemployment offices.6

Although regular FUTA taxes have been more than sufficient to finance the UI system, Congress continues to extend the surtax. Removing the FUTA surtax would reduce the overtaxation of workers' wages by $8.1 billion from 1999 to 2003--an average of $1.6 billion per year. Without the surtax, federal UI accounts still would grow to $33.6 billion in 2003, an increase of 45.4 percent from 1998.7

Workers could bring home more of their real income and enjoy more job opportunities
Legally mandated benefits like unemployment insurance are not "free" to workers. Studies indicate that, on average, over 80 percent of the cost of all employer-paid payroll taxes is shifted to workers in the form of lower real paychecks. When combined with other private-sector mandates, such as increasing the minimum wage, the resulting higher labor costs will affect an employer's decisions about whether and when to hire a worker, which worker to hire, how much cash to pay the worker, and how long to keep that worker. The rise in mandated labor costs paid by employers is one of the most important forces leading companies to lay off workers or use part-time, temporary, and contract labor instead of full-time employees.

State economies would be strengthened
Years of overtaxation have caused an immense amount of money ($23.1 billion in FY 1998) to pile up in trust funds in Washington, D.C.--nearly twice the amounts of three years ago even though employment has increased only 7.4 percent. As Senator Allard said when introducing his legislation, "It is inappropriate for the federal government to continue to raise surplus unemployment taxes and use those surpluses for purposes totally unrelated to the unemployment system."8

Without the FUTA surtax, hundreds of millions of dollars would remain in state economies (see Table 1). For example, Mississippi workers and employers would be able to keep $72.2 million from 1999 to 2003, and the Georgia economy would save $234.9 million.9 Larger states would fare even better. Workers and employers in New York would save $529.1 million from 1999 to 2003, the Texas economy would save $552.7 million, and the California economy would save $892.0 million. These funds would be far more productive used in the private economies of states than piled up in Washington trust funds.

Conclusion

It is time to end the temporary FUTA surtax and return surplus unemployment taxes to workers and businesses. This would reduce the overtaxation of American jobs, allow workers and businesses to keep $8.1 billion more of their hard-earned money over the next five years, and strengthen state economies.

In 1997, Congress mistakenly thought it had to increase revenues in order to balance the budget. In 1998, however, there is no mistaking the fact that the enormous tax burden on American jobs must be reduced.

--Mark Wilson is a former Labor Economist at The Heritage Foundation.

 

Endnotes

1. U.S. Department of Labor, Unemployment Insurance Service, Division of Fiscal and Actuarial Services.

2. U.S. Department of Labor, UI Outlook: Midsession Review of the 1999 Budget, May 1998.

3. Congressional Budget Office, The Economic and Budget Outlook for Fiscal Years 1999-2008: A Preliminary Update, July 15, 1998.

4. In 1993, Congress passed legislation that ended the FUTA surtax after 1998.

5. According to the Congressional Budget Office, the tax burden was higher in 1944 (21.3 percent) and 1945 (20.8 percent), when the United States was locked in a two-front global war.

6. U.S. Department of Labor, UI Outlook: Midsession Review of the 1999 Budget.

7. Heritage Foundation calculations based on U.S. Department of Labor data.

8. Congressional Record, June 16, 1998, p. S6405.

9. Heritage Foundation calculations based on U.S. Department of Labor data.

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