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Critics: Tax hike 'defies logic'

Jobless-fund cure could be felt most by struggling firms

May 4, 2009
The Legislature's plan to shore up the insolvent Indiana Unemployment Insurance Trust Fund places the bulk of the financial burden on already ailing businesses with the least ability to pay.

That's the assessment of the Indiana Chamber of Commerce and Indiana Manufacturers Association, which are howling in protest at Gov. Mitch Daniels' refusal to veto the measure.

"Massive increases in the [payroll tax] rates will have the most impact on companies currently suffering the worst in this record recession," IMA President Pat Kiely said. "The idea that employers with the largest layoffs can somehow fix the fund defies logic."

The General Assembly on the final day of the session approved the rescue plan, which will overhaul the payroll tax rates paid by every business in the state.

Ironically, struggling manufacturers and construction companies will carry the heaviest part of the load, because payroll tax rates are based on a firm's history of job cuts.

Back in 2000, Indiana's unemployment insurance fund had a $1.6 billion surplus. Since then, it's been running in the red. Last year, Indiana collected $579 million for the fund, but paid out $986 million in benefits. To make up the difference, Indiana has been borrowing from the federal government. The debt, now $790 million, is expected to top $1 billion by year's end.

If Indiana's unemployment rate—now at 10 percent—climbs even higher, some experts estimate the debt could quickly become twice as big.

When the session began in January, legislators called the unemployment trust fund issue one of the two "must-solve" problems on their 2009 agenda, along with the state budget. They attempted to tackle it with what boils down to a three-part plan: Increase revenue by raising taxes on employers; improve administration so fewer ineligible claimants collect unemployment; and trim benefits across the board for everyone else in the program.

But massive labor protests obliterated the idea of broad benefit trims. So the centerpiece of the remaining legislation is the business tax hike. Companies pay payroll taxes under a tiered schedule.

Their "experience rating," or history of layoffs, establishes their place higher or lower on the tiers. Under the old schedule, businesses paid between 1.1 percent and 5.6 percent on the first $7,000 in wages per employee. That translates to between $77 and $392 annually for everyone on their payroll.

The new schedule increases the taxable wage base to $9,500. In calendar year 2010, the rates will range from 0.7 percent to 9.5 percent, or $66 to $902 per employee. After that, rates increase to between 0.75 percent and 10.2 percent, or $71 to $969 per employee.

The tax hike is expected to raise $315 million annually for the fund.

"Just as high-risk drivers pay higher premiums for their auto insurance than those motorists who rarely have accidents, businesses that are more likely to lay off workers should shoulder more of the burden," said State Sen. Brandt Hershman, a Wheatfield Republican who chairs the Tax and Fiscal Policy Committee.

"And the 40,000 small businesses who never tap into the fund should be held harmless from rate increases."

Indeed, some small businesses with no record of layoffs actually could end up paying less.

Daniels said he will sign the measure even though it is "very imperfect." One of its strengths, he said, is "it begins to address the unfairness between big businesses, which have been cross-subsidized by small businesses for a long time."

Fraud crackdown

In addition to raising more revenue from payroll taxes, the rescue plan calls for saving $302 million by reforming the claims process to better enforce existing eligibility rules.

Indiana Chamber President Kevin Brinegar said he's happy to see Indiana crack down on unemployment fraud, but considers the savings estimate "a farce."

"We sat in a committee room with Sen. [Dennis] Kruse and with Sen. Hershman two nights ago and we collectively agreed that $300 million number was nonsense, and that at best we might get out of those collection of provisions in the conference committee report $20 million. We don't even know where the $300 million number came from."

The IMA's Kiely said manufacturers could wind up paying an additional $500 or more per employee into the fund, the last thing they need at a time they're already ailing.

"It'll be bayoneting the wounded in the trenches," he said.

Kiely called the solution approved by the General Assembly "insane." As the tax hike begins to affect businesses, he said the more stable ones will grin and bear it. But managers will be forced to make tough choices. If they must pay higher taxes, Kiely said, they'll cut expenses elsewhere to remain profitable, most likely to wages, benefits or total headcount.

Marginal businesses are another matter. Slack demand and a history-making credit crunch has left some struggling to stay afloat. A major tax hike could be the factor that topples some companies, business observers say.

"How do you tell which straw broke the camel's back when 100 [straws] get dumped on at once?" asked Indiana State University economist John Conant.

It could have been worse. Kruse, a Republican from Auburn, pointed out that the House Democrats' version of the bill would have hiked employers' payroll taxes far more dramatically.

Fair solution?

The final plan is fair because it distributes the burden based on how much businesses rely on the unemployment insurance system, Kruse said.

"[Businesses with histories of large layoffs] will pay more money, but that's one of the reasons we're in the mess we're in now. The high-end user is having their employees get far more benefits than they're paying in, and that's been one of the contributors to having the fund go broke," Kruse said. "If you don't fix that, your fund's going to continue to deteriorate."

The tax hike will resonate in boardrooms far beyond Indiana's borders, Conant predicts. He said corporations with operations in other states will analyze costs here and elsewhere, then choose accordingly.

"This is certainly no environment in which to be increasing the cost of employment," he said.

"Multi-plant employers—any large employer these days with facilities in Indiana and other places—will look at where to cut production, which plants to close, temporarily perhaps. The more expensive it is in one place versus another may say something about what you do or don't close."

Even if the plan were to achieve the projected $617 million in combined new revenue and savings, that might not be enough to eliminate the trust fund's annual deficit, said George Raymond, an Indiana Chamber vice president.

Retiring the massive loans from the federal government is another challenge entirely. Kruse said legislators focused on stopping the financial bleeding. Any plan to eventually restore the fund to debt-free status will wait at least until next year.

"That's another day, another battle," Kruse said.

In the end, lawmakers say they did the best they could. They acknowledge the payroll tax hike may harm some companies. But ignoring the insolvency would have allowed the fund's debt to keep growing exponentially.

And Conant said it's the lack of economic growth that's truly crippling businesses. In 2009's first quarter, the U.S. economy shrank at an annualized rate of 6.1 percent.

"The economy itself is going to have far more to say [about company headcounts] than an increase in unemployment taxes," Conant said.

"It's going to have an effect at the margin, but it's probably less harmful to the state than continuing to borrow to make up for the fund." 
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