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Obama to propose relief for states burdened by debt from unemployment benefits

By Lori Montgomery and Brady Dennis
Washington Post Staff Writer
Tuesday, February 8, 2011; 7:34 PM

States that have borrowed billions of dollars from the federal government to cover the soaring cost of unemployment benefits would get immediate relief from the Obama administration under a plan to suspend interest payments for the next two years.

The proposal, which will be included in the budget request President Obama will send to Congress next week, would allow states to avoid raising taxes on employers to cover the payments - which are projected to total $3.6 billion through 2012, according to independent estimates.

Obama also would suspend automatic hikes in the federal unemployment tax scheduled to hit employers in nearly half of the states by the end of next year.

But starting in 2014, Obama would target companies for sharply higher payroll taxes to help states replenish their depleted unemployment funds and repay their debts to Washington.

The proposal was described by an administration source familiar with Obama's budget, speaking on condition of anonymity because the budget has not been released. At a time when Washington is grappling with its own record deficits, this person said the president's proposal would avoid tax hikes on businesses when the economy is weak while ensuring that most states repay the $42 billion they have borrowed since the recession began in 2007.

"The president's proposal does two things that are most important," White House press secretary Robert Gibbs said. "It prevents increases in the federal tax that goes to the unemployment insurance fund, and that's tremendously important given where we are economically. But it prevents future state bailouts, because in the future, states are going to have to rationalize what they offer and how they pay for it."

Republicans quickly blasted the proposal, calling it a tax increase that employers can ill afford.

"I strongly urge the White House to reconsider this job-destroying proposal," Sen. Orrin G. Hatch (R-Utah), the senior Republican on the Senate Finance Committee, said in a statement. "Either employers will have less money to hire or workers will face reduced wages. Neither makes any sense and runs counter to our shared goal of getting the American people back to work."

Rep. Dave Camp (R-Mich.), chairman of the House Ways and Means Committee, said the plan "isn't going anywhere in the House." He added, "We need to reform our unemployment programs, [but] employers are demanding reforms to the unemployment program, not higher taxes on job creation."

Business groups, too, were skeptical.

"What's being proposed by the White House would be very helpful and a big boost in the short term," said Kevin Brinegar, president of the Indiana Chamber of Commerce, whose members face higher taxes starting in April to repay the state's $2 billion loan. But the prospect of big tax increases after 2014, he said, "would be pretty devastating."

In recent years, states have been raising taxes, cutting services and firing workers in an effort to close record budget gaps opened by the recession. With the U.S. unemployment rate stuck at 9 percent or higher for nearly two years, 30 states - including California, Michigan and Nevada - have drained their unemployment insurance funds, forcing them to borrow to pay benefits to jobless workers.

The unemployment system is jointly managed by Washington and the states. The federal government taxes employers on the first $7,000 of wages paid to each worker, and requires states to do the same. Many states set much higher taxable wage bases, however.

In tough times, states routinely borrow from the federal government to pay benefits. But when states have an outstanding balance for at least two years, federal law triggers an automatic increase in the federal tax to repay the loan. Such tax hikes already have taken effect or are imminent in Michigan, Indiana and South Carolina. Employers in at least 20 more states are due to see federal taxes rise by the end of next year, said Iris Lav, a senior adviser at the Center on Budget and Policy Priorities.

Meanwhile, many states impose their own "solvency fees" on employers to cover the cost of interest payments on the debt. In Michigan, which owes Washington $3.7 billion, the second-highest debt after California, employers paid an extra $21 per worker last year, a figure set to double in 2011.

"At a time when that money could be better used to stimulate the economy, this is what employers are facing right now here in Michigan," said Melanie Brown, spokeswoman for the Michigan Unemployment Insurance Agency.

Under Obama's proposal, employers would be relieved of the burden of paying interest in 2011 and 2012. But in 2014, when many analysts expect the economy will have recovered fully, Obama calls for increasing the taxable wage base, requiring states to tax the first $15,000 of each worker's wages.

The change would have no impact on federal tax collections because Obama would adjust the federal tax rate downward. But in 32 states where the wage base is less than $15,000, state legislatures could reap a windfall simply by keeping tax rates the same.

Brookings Institution economist Gary Burtless said the proposal "should be very popular with state legislators and governors," who have been reluctant to raise taxes on employers during hard economic times - even though the $7,000 wage base has been unchanged since 1983.

The administration's proposal offers a "nice sleight of hand," Burtless said, noting that lawmakers in many states could choose to lower rates even as they collect more money by expanding the portion of wages subject to the tax.

"Most economists believe it's better to have a higher tax base and a lower rate," he said.

montgomeryl@washpost.com dennisb@washpost.com

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