Employers in Connecticut and South Dakota face hefty tax increases in the midst of a recession because their states' unemployment insurance trust funds ran dry last week.
The two states, like many others, have solvency taxes -- a special tax increase that kicks in when their trust fund balance goes below a set amount.
In Connecticut, which has borrowed about $40 million so far, an extra 1.4 percent solvency tax has been tacked on to the tax rate businesses normally pay. Last year, the average employer in the state paid a tax rate of 1.7 percent.
In South Dakota, a solvency tax of 1.5 percent kicked in Oct. 1.
The South Dakota increase is especially significant because the state's unusual tax structure has allowed about a third of businesses to pay no unemployment insurance tax at all until now, said Don Kattke, spokesman for the South Dakota Department of Labor.
Even with the tax increases, both states are poised to borrow tens of millions of dollars from the federal government. A provision of the stimulus package allows states to borrow interest-free until 2011, but it will be difficult for states to do so without further tax increases or cuts to benefits just as the economy is predicted to be emerging from the Great Recession.
As a result of a historical compromise, the U.S. has a patchwork unemployment insurance system in which the 50 states, the District of Columbia, the Virgin Islands and Puerto Rico all maintain separate unemployment insurance trust funds. Each is given wide latitude to set benefits and determine how well or poorly financed its fund will be.
Like most of the 22 other states that have borrowed so far — to the tune of nearly $20 billion — Connecticut and South Dakota have over the last five years maintained reserves in their trust funds far below the recommended amount of at least a year's worth. (Read our investigation on unemployment insurance, which we did in partnership with public radio's Marketplace.)
Ideally, during good years states see their trust fund reserves go up, so money can be spent freely to help workers and stimulate the economy during the next recession. But for the past five years both Connecticut and South Dakota's tax rates have generated just enough revenue to cover benefits paid out.
So when the recession struck, both states were forced to raise taxes at the very time when businesses were struggling the most. (Is your state's unemployment system in danger? Check out our chart.)