Exclusive: Historic demands on Colorado unemployment trust fund pose risk of payroll tax hike

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DENVER —  Reports from federal and state analysts show that Colorado’s unemployment trust fund was woefully unprepared for a minor recession in 2020, much less an historic wave of unemployment claims filed over the past several weeks due to the ongoing public health crisis from the COVID-19 virus.

While state officials say they will buffer the trust fund with bonds to make sure that Colorado’s unemployed get the benefits they need, the higher risk of insolvency caused by the COVID-19’s widespread economic effects could lead to higher payroll tax bills for employers next year.

Unprecedented stress

Most businesses in Colorado pay a tax of 1.5% for the first $13,600 of wages paid to an employee in a given year, which is remitted to the state’s unemployment fund. That figure shifts for individual businesses based on their “experience rating,” or how many former employees were paid from the fund in the previous year.

Colorado is one of 22 states with unemployment insurance funds below the recommended solvency standard, according to an analysis of every state and territory in the Union from the U.S. Department of Labor released in February.

The solvency report, released annually since 2014, rates how well-maintained a state’s unemployment insurance fund is and determines which states would be eligible for an interest-free loan from the federal government if it is overwhelmed with claims.

It measures solvency using various formulas comparing how much money a state has in its trust fund against the wages employers pay out in a given year, called the “reserve ratio,” or how much the state paid in benefits against the state’s wage total in the “benefit cost rate” ratio.

The report divides a state’s reserve ratio over the state’s historical highest benefit cost rate to determine a solvency level, which estimates how prepared a state’s trust fund is to pay out claims in case of a major recession. States with solvency levels above one are considered ready to handle the claims load of a recession, while states below it are considered underfunded.

At the beginning of 2020, Colorado’s solvency level was 0.78, meaning that it has the funds to meet only 78% of the demand from its historical highs.

The state’s solvency level is 15th-lowest among U.S. states and territories. It is among the 19 that aren’t eligible for interest-free loans from the federal government through the Social Security Act in the event they need to borrow.

Years of underfunding

The state labor department’s 2019 report on the trust fund estimated it would have nearly reached solvency in 2021 before that ratio would fall again to .68 by 2024.

That’s because while the taxable wage base is increasing, the average tax rate that employers pay on those wages are decreasing in tandem, while claimants would be eligible for more unemployment benefits because wages have increased.

The report expects the benefit cost rate, or how much the state pays in a year compared with how much it has in its trust fund, to rise from 28 percent in 2019 to 40 percent by 2024.

Under a stress-test model, Colorado’s trust fund would run out of money in early 2022 and bounce between solvent and insolvent until mid-2023 in a moderate recession this year. But under a scenario similar to the Great Recession, the trust fund would run out of money in early 2021 and remain so through 2024 with an estimated peak recession insolvency of $1.1 billion.

In those events, the report suggests the possibility of needing to add fees on local employers in case of a recession.

“Despite Colorado’s impressive economic gains since 2012, the fund may become insolvent again during the next recession thereby requiring a future round of borrowing that will lead to additional surcharges borne by Colorado employers,” the report reads.

Neither the federal report nor the state-level report were created to model the effects of entire industries across the U.S. shutting down in unison.

However, Todd Ely, director of the University of Colorado Denver’s Center for Local Government Research and Training, said it’s highly likely the state will need to borrow millions to stay solvent and pay out claims for Coloradans because the current economic crisis has grown more intense in a faster period of time than any existing models could have predicted.

“CDLE’s own stress test suggests multi-year insolvency in the case of a severe recession beginning in 2020. This stress test likely understates the actual financial demands given the outsized impact on employment of the current crisis,” he said.

Colorado borrowed just more than $600 million from the federal government during the Great Recession and later refinanced that debt with lower-interest private bonds.

The state’s cap on how much employers had to pay per employee salary was frozen at $10,000, ignoring decades of economic changes, inflation and increases to the average worker’s wage.

There have been some efforts to shore up the trust fund. In 2011, then-Gov. John Hickenlooper signed a unemployment insurance reform measure meant to shore up the fund by increasing the limit on payroll taxes paid by employers from the first $10,000 per employee to the first $11,000.

Those changes went into full effect in 2013 and aren’t limited by TABOR revenue rules.

But despite the reforms, Colorado’s solvency ratio has improved from being able to cover only 53% of its historical high in 2014 to 78% today.

While the base wage rates have increased intermittently in the past decade, CDLE’s report estimates that Colorado would have to set the payroll tax to take effect on the first $28,000 of a covered worker’s salary to reach parity with 1988’s levels.

Going private

If Colorado decides against asking for a federal loan, it may find willing bond providers in the private market.

The states in general may look towards the private market, as credit is cheap due to the Federal Reserve’s decision to begin unlimited buying of corporate and municipal bonds two weeks ago. As of April 3, the federal government charges an interest rate of 2.4% for an advance UI loan.

Credit-rating firm Moody’s puts Colorado in its highest-possible investment grade, while Standard and Poor’s believes the state’s credit rating is strong because of a diverse economy that has “better-than-average income, employment, and population trends,” according to its latest report in February.

Ladunni Okolo, an associate director at S&P Global Ratings and the author of the report, told BizWest that she doesn’t expect Colorado’s credit rating to drop if it were to take out a bond to shore up the trust fund because the state’s economy was strong pre-pandemic and is likely to stay stronger than other states.

A portion of that confidence is derived from credit analysts believing that Colorado’s employers will be able to repay that bond over time while refilling the trust fund through regular levels of payroll taxes.

“There’ll be a spike, but on a competitive basis, we should realize all of the states are facing this too,” said David Hitchcock, a senior director at S&P Global Ratings.

More costs for employers?

Any increase in the wage base or premiums would mean more money out of the hands of businesses, mostly during recovery periods after a recession or in periods of heavy growth.

Tracy Gordon, a state budget researcher at the Urban Institute, said there are pros and cons based on whichever way a state decides to backstop its trust fund.

While the federal interest rate is higher than what could be available from private sources, she notes that the federal government after the last recession delayed when states had to start repayment into 2009 and 2010. That isn’t exactly the case for a private bond provider unless an agreement is specifically structured that way.

Either way, she expects that states will try to be sensitive toward levying heavy surcharges on its businesses.

“I think policymakers are going to be very attuned to that, to try and avoid exactly that scenario, especially given the number of small businesses affected by this,” she said. “The sense is that this wasn’t anybody’s fault, and there were businesses that were thriving that are now not because the economy has been necessarily shut down.”

Uncertainty abound

State officials are already trying to minimize any increases in payroll-tax costs, particularly at the individual-employer level. CDLE senior economist Ryan Gedney said the department won’t penalize employers who laid off staff within a period this year that encompasses the worst economic damage from the COVID-19 virus.

That will be incorporated into data compiled on June 30, which is used to determine premiums in 2021.

More than 173,000 state residents have filed for unemployment in the past four weeks, temporarily overwhelming Colorado’s unemployment call centers and online application servers. That figure is likely to continue increasing in the coming weeks as more employers are forced to cut staff, and because the state will soon begin accepting claims from contract employees, self-employed residents and other workers who traditionally aren’t eligible for unemployment insurance.

The state paid out approximately $29.8 million in benefits in the week ending April 4. In a separate call with reporters Thursday, Gedney said he believes the benefit payout amount for the week ending on April 11 is likely to exceed $50 million.

CDLE spokeswoman Cher Haavind said the department’s primary goal right now is to make sure that claimants are getting approved and receiving their benefits on time, but state officials will reach out to the business community soon to have a conversation about 2021’s premium rates.

But as of mid-April, CDLE doesn’t have enough of a sample size to say with any certainty that the trust fund will run out of the funds it had before the virus struck, or how much it would have to borrow if it needs to backfill its coffers.

The other key factor is in how quickly the economy recovers. If the U.S. and other countries manage to develop an effective strategy to flatten the curve of new COVID-19 infections within the next several months and people working in non-essential industries can return to work, it’s possible the fund wouldn’t run dry.

When that recovery comes is the key question for not just the trust fund, but for all of American society.

“I don’t think today, with two weeks of data, we can say where we will or won’t be at the end of the year,” Haavind said.

Loren Furman, senior vice president of state and federal relations at the Colorado Chamber of Commerce, said it’s too early to determine exactly what that conversation between businesses and the labor department would look like.

Right now, there’s too much uncertainty over whether the state actually will have a shortfall and how much that could be, and many employers don’t know if they can even stay open long enough to see the new rates take effect.

While the chamber believes that CDLE is handling the rapid demand for benefits well, Furman said it hopes the state can avoid adding a payroll surcharge.

“I’m sure it scares the heck out of our employers,” she said. “… Being faced with yet one more increase to your costs is just going to create more of a burden on those employers that don’t even know what their bottom line is going to look like.”

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