The states, when they borrowed the money, hoped that the economy would have turned around by the time the first interest payments came due, or that future Congresses might loosen the terms. But the economy did not turn around in time and the new Congress, dominated by Republicans determined to shrink the size of government, shows little appetite for deepening the federal deficit by bailing out the states.
The problem is not only the staggering number of people who have lost their jobs, but the fact that many states entered the downturn with too little money salted away in the trust funds they use to pay unemployment benefits, which they are supposed to build up in good times by taxing employers.
Those anemic trust funds ran dry quickly in many states as millions of newly jobless Americans began collecting benefits. So many states borrowed money from the federal government, helped by the stimulus act, which gave them a break on interest for nearly two years. But that grace period ended Dec. 31, and states will owe the first interest on those loans in September.
Michigan, which owes Washington $3.7 billion, is supposed to pay $117 million in interest by September — just about what it pays each year to run Western Michigan University. California, which owes $362 million in interest on a total debt of $9.7 billion, the highest in the nation, plans to juggle its accounts, borrowing from a trust fund for disabled workers to pay interest to the federal government.
In New York, which owes $115 million in interest on $3.2 billion, the cost will be passed on to employers in the form of a tax surcharge. Texas went to the bond market and borrowed $2 billion to pay back all the money it borrowed from the federal government, judging that the interest on the bonds, which are backed by a tax on employers, would cost less.
Some states are planning to follow the lead of Texas, and borrow the money to repay the federal government. Others are asking for more time.
“During this time of extreme economic stress not only on the citizens of our states, but also on state budgets, state loan interest payments that will come due in September 2011 place further hardship on states’ finances and could slow economic recovery,” a group of 14 governors from both parties wrote to Congressional leaders last month. Their letter added: “Extending the interest-free loans would allow states to avoid increasing payroll taxes, reducing benefits, or both, while the economic recovery continues.”
Many advocates believe that the new Republican majority in Congress, which has said it plans to focus on deficit reduction, may be hesitant to postpone collecting the interest. But they could face pressure from newly elected Republican governors in states like Michigan, Ohio, which owes $2.3 billion, and Florida, which owes $2 billion.
The effects of the problem are already being felt. While states are generally loath to increase taxes on businesses during a recession, for fear that it can discourage much-needed hiring, 35 states were forced to raise their state unemployment taxes on employers in 2010, according to a survey by the National Association of State Workforce Agencies.
If states are unable to repay their outstanding federal loans by November — which will prove difficult for many — nearly half the states could be forced to effectively raise federal taxes on employers by about $21 per worker, under a provision of federal law that automatically reduces the tax credits given to businesses in states that carry loans two years in a row. Businesses in Michigan, Indiana and South Carolina are already paying the higher federal tax.
But even with those effective federal tax increases, which would continue to rise each year the loan is not repaid, it could take years for some states to repay what they have borrowed.
“This is a problem that’s going to persist because of the structural imbalances in the way this system is financed,” said Patrick T. Beaty, a deputy secretary of the Pennsylvania Department of Labor and Industry, who explained that Pennsylvania’s unemployment tax base had not kept up with the rising cost of the benefits, leading to a chronic insolvency.