COLORADO WAGE GROWTH AND THE UNEMPLOYMENT INSURANCE TRUST FUND 
by Michael Rose, Colorado Department of Labor and Employment

 

xtraordinarily low unemployment rates in Colorado have helped boost to very high levels the amount of money available with which to pay unemployment benefits.  As of this writing, the balance in the State’s unemployment insurance trust fund is approximately $770 million, an amount unsurpassed at any prior time in the fund’s existence.

 

The fund balance is simply the difference between the accumulated amount of contributions or taxes paid into the fund by employers plus interest earned on the balance minus the total amount of benefits paid to beneficiaries.  Partly because of the political sensitivity surrounding that part of the unemployment insurance system related both to tax rates and revenue limitations imposed on government entities, considerable attention historically has been paid to the revenue side factors affecting the fund balance.  However, the expenditure portion of the unemployment insurance system plays an equally important role in the solvency and performance of the fund. 

 

In this article, we briefly examine some ways in which rising wages influence the unemployment insurance trust fund through the linkage between wages, fund revenues and benefit payments.  Using the trust fund financing model, we then illustrate the fiscal impact upon the fund under a variety of wage regimes.

 

Overview of the UI System.  Before looking at the influence of wages upon the trust fund, we review the way in which revenues and expenditures related to the fund take place.  A simplified account of some basic elements of the Colorado UI system are summarized in the following paragraphs, ignoring much of the detail and complexity that is part of the financing system.

 

The various types of employment and industries subject to unemployment insurance are defined in the Colorado Employment Security Act.  Workers covered by unemployment insurance are sometimes referred to as covered workers and their earnings are known as covered wages.  Although most of the State’s workers are covered by the Act, notable exceptions include certain groups of nonprofit, domestic, and agricultural workers.  Of Colorado’s 2,198,147 employed residents in 1999, about 2,105,286 or nearly 96 percent were considered covered workers for purposes of unemployment insurance. 

 

Employers currently pay unemployment insurance taxes on the first $10,000 of each covered worker’s earnings during the calendar year—the $10,000 limit is known as the maximum taxable wage base.  Earnings from any given covered employer exceeding the $10,000 threshold are not taxed.  The amount of covered earnings up to $10,000 are referred to as taxable wages in order to differentiate them from total earnings, which may include some part not subject to tax.

 

The maximum taxable wage base applies to employers, not employees.  Thus, for someone earning exactly $10,000 annually but whose earnings are evenly split between two employers, the liable employers would pay UI taxes on the entire earned amount of $5,000— the total and taxable wage amounts are identical.  On the other hand, only the first 10 percent of earnings are taxed for an employee whose earnings from a single employer totaled $100,000.  Had the same individual worked for two covered firms and earned $50,000 from each, the employers would pay taxes on the first $10,000 that each paid to the employee. 

 

The level of contributions paid into the fund is dependent upon both the quantity of taxable wages and employer tax rates.  For most employers, rates are a function of the amount by which contributions paid by an individual employer exceed benefits charged against the employer’s account-- benefit charges essentially act as a proxy measure of employer layoff activity.  Rates are directly related to benefits charged relative to contributions paid into the system, so that employers with relatively fewer benefits charged against them have tend to have lower tax rates while those with more benefits charged to them generally have higher tax rates.[i]

 

Benefits paid are based upon wages earned by workers during what is termed their base period employment.  The base period for benefit determination consists of the most recent four consecutive quarters (with a one quarter lag from the current filing period) during which wages are earned from covered employment.  Benefit amounts are figured as some share of base period wages.  The important consideration for our purpose is that benefits paid to beneficiaries depend upon total wages earned rather than taxable wages.  The maximum weekly amount potentially payable to beneficiaries is established each year and is capped at approximately one-half of the State average weekly wage for private sector covered workers.     

 

Rising Wages and Trust Fund Revenues.  Annual earnings of $10,000 roughly correspond to what a person working 40 hours per week and currently earning the federal minimum wage would earn in the course of a full year’s employment.  According to unpublished Current Population Survey data from

the U.S. Bureau of Labor Statistics, only a small number of Colorado workers had hourly wages lower than $5.15 in 1998 (approximately 40,000 out of more than 2.1 million wage and salary workers).  The great majority of Colorado workers thus earned hourly wages that if converted to full-time employment (here meaning 40 hours or more per week for 52 weeks) would equal or exceed the taxable wage base of $10,000.  An increase in the hourly wages of most full-time workers would lead to virtually no incremental increase in trust fund revenues simply because these persons had earnings which already exceeded the taxable wage base, i.e., their base period earnings were $10,000 or greater.  In this case, total wages rise by the amount related to the wage gain but taxable wages would remain flat.  Since taxable wages are marginally affected in this instance, revenues flowing into the trust fund are also only slightly increased.

 

For hourly workers employed for fewer than 40 hours a week, the impact of rising wages upon fund revenues depends upon the wage rate in conjunction with the number of hours worked.  For example, someone working 10 hours per week at an hourly rate of $10 per hour would earn about $5,200 per year and the liable employer would pay taxes on the entire amount of the earnings.  Doubling the hourly wage and holding the number of hours fixed would double annual earnings or total wages to $10,400.  Taxable wages would expand by $4,800 or just less than the increased amount of total wages since the maximum taxable wage base is reached at $10,000.  Further increases in either the number of hours worked or in hourly earnings would result in no revenue gain to the trust fund because there is no corresponding change in taxable wages.

 

For this reason, wage gains by Colorado workers may not lead to proportionally large gains in trust fund contributions.  New job growth, however, does mean an increase in fund revenues, since each new job always represents an addition to taxable wages regardless of the amount of wages earned (multiple job- holding by individuals, because it is a form of new job growth, has the same impact upon fund revenues).  While both total and taxable covered wages have expanded over the last ten years, taxable wage growth has significantly trailed the gains in total wages for the State throughout most of the 1990s.  This trend is likely to continue over the next five years.

When the maximum taxable wage base was increased to its current level of $10,000 in 1988, average covered wages for private sector workers was $21,113, so that the maximum wage base as a percent of average wages equaled 47 percent.  With current private sector annual earnings in Colorado at $34,316, the maximum taxable wage base now represents only about 29 percent of average annual wages.  Over the same period, total wages paid by covered employers increased threefold while taxable wages doubled.  As a result, the share of taxable to total wages has fallen from almost 45 percent to 33 percent.  By 2005, taxable wages are forecast to make up only about 25 percent of total wages.  These measures are evidence of the erosion of the trust fund’s revenue generating ability in the sense that a given rise in total wages has generated an increasingly smaller than proportional increase in taxable wages.

 

The significance of a weakening of the fund’s revenue yielding potential is that, unless offset by continued strong job growth, employer contributions paid into the fund will change little over time and might thereby restrain growth in the fund balance.  In fact, fund revenues have been relatively flat since the early 1990s, varying between $172 million and $191 million from 1992 to 1999.  However, over the same period the fund balance climbed from about $327 million to $705 million due to the unprecedented magnitude of economic growth over the past decade.  The creation of more than 600,000 new jobs in the State since 1990 along with consistently low levels of benefit payments and larger interest earnings have thus far compensated for the deterioration of the fund’s revenue capacity.

 

Rising Wages and Trust Fund Benefits.  Overall benefit payments rise and employer contributions decline during periods of depressed economic activity; the opposite occurs during periods of strong economic growth.  In this way the unemployment insurance system helps maintain levels of aggregate demand in the economy, thereby acting as a macro or large-scale automatic counter cyclical stabilizer.            

 

At a micro level, the system functions as an income replacement program for workers laid off due to the drop in product demand associated with economic downturns.  Because of the work disincentives linked to unemployment insurance payments, benefits are generally capped at some percentage of typical earnings.  In Colorado and many other states, maximum benefit amounts are usually set at around one-half of average weekly wages. 

 

Average private sector weekly wages in the State increased from $389 to $665 between 1986 and 1999, a 71 percent gain.  Of course, as average earnings have risen over time, so, too, have the base period earnings of workers used to determine their allowable weekly benefits.  Consequently, average Colorado unemployment benefits climbed from $155 in 1986 to $236 in 1999, a rise of about 52 percent.    

As the State’s unemployment rate has fallen to among the lowest in the nation, the number of weekly benefits claimed have dropped sharply throughout the last decade.  For example, the weekly average number of weeks claimed in 1992 was 26,401; by 1995, this figure had declined to 21,919.  In 1999, the average number of weeks claimed plunged still further, totaling only 15,908.  Although the average benefit amount paid to Colorado UI claimants has grown, total benefits paid out from the trust fund have slid significantly due to the large decrease in the number of weeks paid to beneficiaries.  Benefit payments, which totaled about $177 million in 1992, dropped to just more than $154 million last year.

 

Fund Simulations.  We can evaluate the impact of rising wages upon the trust fund by utilizing an unemployment insurance trust fund financing model.  The model allows fund forecasts to be made by manipulating three main variables:  the insured unemployment rate, and the rate of growth in both covered wages and covered employment.  By holding constant the insured unemployment rate and the pace of job growth while varying the growth in covered wages, it is possible to see how differences in wage growth might affect the trust fund balance.

 

For purposes of this discussion, the insured unemployment rate was held constant at 1.08 percent while the annual average growth in covered employment was fixed at 2.63 percent over the forecast period 2000- 2005.  The following table summarizes how these values compare with averages for various periods during the 1990s.

 

	1990-99 Average	1995-99 Average	1997-99 Average	Forecast 2000-05
Annual Insured Unemployment  Rate	1.33 %	1.04 %	0.89 %	1.08 %
Annual Growth Covered Employment	4.12 %	4.58 %	4.4 %	2.63 %
Annual Growth Covered Wages	4.79 %	5.98 %	6.92 %	Varied

 

 

The trust fund forecasting model was used to generate trust fund estimates with wage growth selected to match actual growth rates that prevailed during different periods over the last decade.  For the high wage forecast, UI covered wages were set to rise at 6.92 percent each year, a rate that corresponded to Colorado covered wage growth from 1997 to 1999.  In the medium wage outlook, wages were forecast to increase by 5.98 percent per year, a pace that paralleled wage growth from 1995 to 1999.  Finally, a low wage forecast was made in which wages increased by 4.79 percent annually, a rate mirroring State wage growth for the entire period 1990 to 1999.

 

The results of the fund simulations are summarized below.  The forecast difference in fund revenues is negligible for all three forecasts because, as we saw earlier, growth in taxable wages has been only moderately affected by rising wages. 

 

	CY 2005 Trust Fund Balance (millions)	Cumulative Revenues 2001-05 (millions)	Cumulative Benefits Paid 2001-05 (millions)
Low Wage Forecast	$479.5	$1,279.9	$1,564.6
Medium Wage Forecast	$405.1	$1,276.4	$1,641.5
High Wage Forecast	$341.3	$1,280.2	$1,704.8

 

The outcomes are as expected.  For fixed levels of unemployment and job growth, a condition of persistently high wage growth results in higher benefit payments and consequently, a lower trust fund balance.  During the forecast period, the cumulative difference between wages rising by about 7 percent each year and wages increasing by roughly 5 percent annually means $140 million more paid out to beneficiaries.  This $140 million represents the difference in the trust fund balance between the high and low wage forecasts. 

 

Implication for the Colorado Trust Fund.  Colorado’s covered wage gains have, for several years, been among the highest in the nation.  Very low unemployment rates and robust job growth have pushed unemployment benefit payments to relatively low levels and contributed to an expanding unemployment insurance trust fund balance.   However, rapidly rising wages by themselves have had little impact upon fund revenues, which are much more sensitive to new job creation.  

 

A trust fund financing model was used to demonstrate that even under continued conditions of low unemployment, a combination of moderating job growth and sturdy wage growth may begin to have a negative impact on the fund balance.  The degree to which even relatively small differences in annual wage growth can influence the amount of benefit payments over a five-year period was estimated to be roughly $140 million.  Should unemployment rise at the same time, something not forecast in the fund simulations, an even greater negative impact upon the trust fund would be expected to result.  Such an outcome points to the vulnerability of the fund to changing economic conditions.