The Heritage Foundation

Backgrounder #1287

May 27, 1999

May 27, 1999 | Backgrounder on

How Congress Can Lower Federal Taxes on American Jobs

Despite constant talk of Social Security's trust fund surplus, the Social Security payroll tax is not the only federal tax accumulating excess tax dollars in Washington, D.C. Between 1992 and 1998, a little-known payroll tax under the Federal Unemployment Tax Act (FUTA) generated a substantial trust fund balance of $23.4 billion. As Congress considers ways to return part of the current budget surplus to taxpayers, a good first step would be to examine the FUTA payroll tax, which includes a permanent tax on wages as well as a temporary surtax.

WHAT THE FUTA SURTAX FUNDS

The third-largest tax increase included in the Taxpayer Relief Act of 1997 was the extension of the temporary FUTA surtax, which was scheduled to expire at the end of 1998. Established in 1976 to help to restore the depleted federal Unemployment Insurance (UI) trust funds, the surtax first was set to expire in 1987. Since 1987, however, it has been extended five times--despite having accomplished its goal. Frequently, the surtax was extended in order to offset other tax cuts and credits.

In 1997, Congress extended the FUTA surtax through December 31, 2007, because many Members thought they needed to increase tax revenues to balance the budget. As a result, the tax burden on American workers has hit a post-World War II high, and surplus unemployment taxes continue to be used for purposes totally unrelated to the unemployment system. Surplus FUTA surtax revenue that builds up in federal trust funds, like the Social Security payroll tax, is converted to federal government bonds and spent as general revenue--instead of being set aside for the UI system.

The revenue from the FUTA tax is designated for the administration of the 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. The repeated extension of the "temporary" surtax has caused federal UI trust fund balances to balloon--from $4.9 billion in 1987 to $23.4 billion in 1998.1 And because of the 1997 extension of the surtax, these trust fund balances are forecast to reach an astounding $43.9 billion by the end of fiscal year (FY) 2004 (see Chart 1).2 From FY 2000 to FY 2004, 46.3 percent of the increase, or $5.3 billion, is scheduled to come directly from the FUTA surtax.

To their credit, some Members of Congress are not only aware of the burden this extension of the surtax is placing on workers, employers, and state economies, but they are also trying to correct the problem. For example, Senator Wayne Allard (R-CO) has introduced legislation this session (S. 103) to repeal the FUTA surtax; and Senator Mike DeWine (R-OH) introduced the Employment Security Financing Act of 1999 (S. 462) to repeal the surtax and significantly reform how the employment security system is financed.3 Together, these two efforts would enable workers and employers to keep $8.3 billion more of their hard-earned money over the next five years--which is just 0.9 percent of the projected budget surplus.4 Congress should honor the promise it made to taxpayers in 1993 to end the temporary FUTA surtax and take this small step toward lowering the tax burden on American jobs.5

WHY THE FUTA SURTAX SHOULD BE ENDED

As Senator Allard observed, "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."6 There are three very important reasons that Congress should end the FUTA surtax:

  • Ending the surtax would end the unnecessary overtaxation of work.
    In FY 1999, the federal tax burden is expected to reach a record peacetime high of nearly 20.7 percent of economic output.7 Only $3.5 billion (54 percent) of the $6.5 billion in projected FUTA tax collections in FY 1999 will be returned in federal grants to administer state unemployment offices.8 Although these regular FUTA taxes have been more than sufficient to finance the UI system, Congress continues to extend the surtax.

Ending the FUTA surtax would reduce the overtaxation of work by $8.3 billion between FY 2000 and FY 2004--an average of $1.7 billion per year. Yet ending the surtax would not endanger federal UI trust fund balances; its accounts would continue to grow to $38.6 billion in FY 2004, an increase of 38.7 percent over FY 1999.9

  • Ending the surtax would eliminate inconsistent tax policy.
    In 1997, Congress increased payroll taxes on American jobs by extending the FUTA surtax on wages to 2007; then it passed two tax credits for employers, the Welfare-to-Work Tax Credit and the Work Opportunity Tax Credit, to lower the cost of hiring unskilled workers. This clear conflict--raising taxes on the one hand only to cut taxes on the other--defies sound public policy and undermines trust in Congress's stated desire to lower the tax burden on Americans. By comparison, since 1992, 18 states have cut their state UI benefits tax rate to encourage job growth and to control the size of their own UI trust funds.10

  • Ending the surtax would help to strengthen state economies.
    Years of overtaxation have caused an immense amount of money ($23.4 billion in FY 1998)11 to pile up in trust funds in Washington, D.C.--more than twice the amounts collected just three years ago even though employment increased only 7.4 percent. Ending the FUTA surtax would facilitate the flow of tens to hundreds of millions of dollars into state economies instead of into ballooning federal trust funds (see Table 1). For example, ending the surtax would allow workers and employers in Mississippi to keep $74.1 million more between FY 2000 and FY 2004, which they could spend, save, or invest; in Connecticut, workers and employers would see their taxes cut by $109.3 million.12

Ending the FUTA surtax would have even better results for the economies of larger states. For example, workers and employers in Illinois would save $386.8 million in taxes from 2000 to 2004; in Texas, $582.3 million; and, in California, $925.5 million.13 Keeping more money in the private sector and allowing it to flow into the economies of the states would be far more productive than letting surplus taxes pile up in trust funds in Washington, D.C.

CONCLUSION

It is time to end the "temporary" FUTA surtax, which has been extended five times since 1987 despite record surpluses in the Unemployment Insurance trust fund, and return surplus unemployment taxes to workers and employers. Ending the FUTA surtax would reduce the overtaxation of American jobs, allow workers and employers to keep $8.3 billion more of their hard-earned money over the next five years to spend or invest as they see fit, and strengthen state economies.

In 1997, when Congress last extended the FUTA surtax, Members mistakenly thought they would have to increase tax revenues in order to balance the budget. The current budget surplus has enabled both sides of the political aisle to consider the best way to give hard-working Americans much-needed tax relief. Ending the FUTA surtax would be one small but good first step toward lowering the tax burden on workers and reestablishing sound and coherent fiscal policy.

D. Mark Wilson is a former Labor Economist for The Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.

Endnotes

1. U.S. Department of Labor, Unemployment Insurance Service, Division of Fiscal and Actuarial Services. Historical data faxed to author.

2. U.S. Department of Labor, Unemployment Insurance Service, Division of Fiscal and Actuarial Services, UI Outlook: President's Budget 2000, January 1999. Strong employment growth since 1993 also has contributed to the increase in federal trust fund balances.

3. In the 105th Congress, Representative Clay Shaw (R-FL) introduced the Employment Security Financing Act of 1998 (H.R. 3684). To date, no similar legislation has been introduced in the House this session.

4. Congressional Budget Office, The Economic and Budget Outlook: Fiscal Years 2000-2009, January 1999. Studies indicate that, on average, over 70 percent of the cost of all employer-paid payroll taxes is shifted to workers in the form of lower real wages. See Patricia M. Anderson and Bruce D. Meyer, "The Effects of Firm Specific Taxes and Government Mandates with an Application to the U.S. Unemployment Insurance Program," Journal of Public Economics, August 1997; and Jonathan Gruber and Alan B. Krueger, "The Incidence of Mandated Employer-Provided Insurance: Lessons from Workers Compensation Insurance," Tax Policy and Economy (1991).

5. In 1993, Congress passed the Omnibus Budget Reconciliation Act of 1993 (Public Law 103-66) that ended the FUTA surtax on December 31, 1998.

6. Senator Wayne Allard, in introducing S. 103 to repeal the temporary unemployment tax. See Congressional Record, January 19, 1999, p. S539.

7. According to the 1999 Economic Report of the President, the federal tax burden was higher only in 1944 (20.9 percent), at a time in which the United States was locked in a two-front global war.

8. U.S. Department of Labor, UI Outlook: President's Budget 2000.

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

10. In addition to the three federal UI trust funds that are used for administrative expenses and paying extended benefits, each state has its own UI benefit trust fund from which regular weekly UI benefits are paid.

11. U.S. Department of Labor, UI Outlook: President's Budget 2000.

12. Heritage Foundation calculations based on U.S. Department of Labor data. Studies indicate that workers would receive most--70 percent--of the tax cut in the form of higher wages; employers would receive the other 30 percent. See footnote 4.

13. Ibid.

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