Unemployment Compensation: The Fundamentals of the Federal Unemployment Tax

Summary

The Federal Unemployment Tax Act (FUTA) of 1939 specifies the financing arrangement for the Unemployment Compensation (UC) program. Revenue for the program is provided through payroll taxes levied by both the federal government and the states on a portion of wages paid by covered employers. Total UC expenditures include benefit payments and administrative costs.

Federal unemployment taxes are deposited with the U.S. Treasury and credited to the federal accounts within the Unemployment Trust Fund (UTF). Federal unemployment taxes pay for state administrative costs, half the cost of Extended Benefits (EB), and loans to insolvent state UC programs. State unemployment taxes are deposited into the UTF and credited to the corresponding state account. State unemployment tax revenue is limited to paying each state’s regular UC benefits and the state’s half of EB costs. In budgetary terms, UC benefits are mandatory spending because the underlying law authorizes the Treasury to transfer funds to the states for UC benefit payments without the need for further appropriation.

FUTA imposes a gross federal payroll tax on employers of 6.0% on the first $7,000 paid annually to each employee. As an incentive to comply with the framework, FUTA lowers the net federal unemployment tax to 0.6% if the state UC program follows the federal requirements. States must follow FUTA guidelines on what types of employment must be covered by UC; and state unemployment taxes on employers must meet FUTA’s parameters. All states comply with these guidelines. Because most employees earn more than the $7,000 taxable wage ceiling in a year, the federal unemployment tax paid by an employer is typically no more than $42 per worker per year.

Federal unemployment tax revenue for FY2016 is projected to be $5.8 billion, whereas state unemployment tax revenue is projected to be $41.4 billion. The federal unemployment tax financed expenditures are projected to be approximately $4.2 billion—approximately 12% of all UC expenditures. In comparison, state financed UC expenditures are projected to be $32.2 billion—approximately 88% of all UC expenditures.

There remains significant state independence within the broad parameters set by FUTA. States generally determine individual qualification requirements, disqualification provisions, eligibility, weekly benefit amounts, potential weeks of benefits, and the state tax structure used to finance all of the regular state UC benefits and half of the EB.

Since 1940, Congress has increased the FUTA wage base three times: from $3,000 to $4,200 in 1972; from $4,200 to $6,000 in 1978; and from $6,000 to $7,000 in 1983. Congress has permanently increased the net FUTA tax rate three times: from 0.3% to 0.4% in 1965, 0.5% in 1970, and 0.6% in 1983. There also have been three temporary (surtax) tax rate increases of short duration (from 0.4% to 0.8% in 1962, from 0.4% to 0.65%; in 1963, and from 0.5% to 0.58% in 1973). In addition to these short-term changes, a temporary 0.2% surtax began in 1977 and was continually reauthorized (nine times) until finally lapsing at the end of June 2011—a span of over 34 years.

The combination of increases in the wage base and the doubling of the tax rate has not kept pace with inflation or wage growth, and the proportion of total revenue to total covered wages continues to decline. By 2015, the net federal unemployment tax revenue was equivalent to an effective tax rate of 0.1% on the total wages in covered employment.