Employers and the state government split the cost

Unemployment benefits come from two sources: employer payroll taxes and state general revenue. Employers pay most of it through a tax on their payroll, which funds the state unemployment insurance trust fund. When that fund runs low — usually during recessions — the state legislature may appropriate money from general tax revenue to keep payments going. The federal government does not fund regular unemployment benefits, though it has stepped in during national emergencies like the 2020 pandemic.

The amount each employer pays varies by state and by their own history of laying off workers. An employer with few layoffs pays a lower tax rate; an employer with many pays a higher one. This creates an incentive for businesses to keep workers on the job rather than laying them off, since layoffs directly raise their tax bill.

When you receive an unemployment check, you are receiving money that your employer (or employers, if you worked for several) paid into the system while you were employed. You are not receiving charity or a loan. The money was set aside for this specific purpose.

Key Takeaways

  • Employers pay the vast majority of unemployment insurance through payroll taxes that vary by state and by their layoff history.
  • State governments contribute from general revenue when the unemployment trust fund depletes, which happens during recessions.
  • The federal government funds only temporary programs during national crises, not the regular weekly benefit amount.
  • Your benefit payment comes from money your employer paid into the system while you worked, not from general welfare funds.
  • The employer tax rate is higher for businesses with more layoffs, creating a financial reason to avoid mass terminations.

How employer payroll taxes work

Every employer in the United States pays a federal unemployment tax (FUTA) of 6 percent on the first $7,000 of each employee's annual wages. However, employers in states with approved unemployment insurance programs receive a credit of up to 5.4 percent, so the net federal tax is typically 0.6 percent. The state then collects its own unemployment insurance tax on top of this.

State unemployment tax rates range widely. In some states, the minimum rate is around 0.5 percent of payroll; in others it is 1 percent or higher. The maximum rate can reach 5 percent or more, depending on the state and the employer's record. A new business usually pays the average rate for its industry. After a few years, the rate adjusts based on how many former employees have drawn benefits after leaving that employer.

Employers cannot pass this tax directly to workers by reducing wages — it is a separate business expense. However, some economists argue that over time, high unemployment taxes in a state may reduce wage growth or hiring, since the tax reduces the money available for payroll.

When state general revenue fills the gap

The unemployment trust fund in each state is built up during good economic times when layoffs are low and tax revenue is high. During recessions, layoffs spike, benefit payments rise sharply, and the fund can be depleted within months. When the fund balance falls below a certain level, the state legislature must decide whether to raise employer tax rates, cut benefit amounts, or transfer money from the state's general budget.

Most states choose a combination of all three. Some states have borrowed from the federal government to cover benefits during deep recessions, then repaid the loan by raising employer taxes over several years. During the 2008 financial crisis, many states went into debt to the federal government; some did not finish repaying until 2015 or later.

The state legislature controls this decision, not the unemployment insurance agency. The agency administers the program and pays out benefits, but lawmakers decide how to fund it when the trust fund runs short. This is why unemployment benefit amounts and tax rates vary so much from state to state.

Federal funding during national emergencies

The federal government normally does not fund regular unemployment benefits. However, during the 2020 pandemic, Congress created three temporary federal programs: the Pandemic Unemployment information (PUA), Pandemic Emergency Unemployment Compensation (PEUC), and a $600 weekly supplement to regular benefits. These were fully funded by federal appropriations, not by employer taxes.

These programs expired in September 2021. The federal government has not created similar programs since then, though Congress could do so if another national emergency occurs. Regular state unemployment benefits remain funded by employer payroll taxes and state revenue.

Some people confuse federal funding with federal oversight. The federal government sets minimum standards that states must meet — for example, states must pay benefits for at least 26 weeks — but states design and fund their own programs within those rules.

Why the funding model matters to you

Understanding who pays helps explain why benefits vary so much by state. A state with high employer taxes can afford higher benefit amounts and longer benefit periods. A state trying to keep employer taxes low may pay lower weekly amounts or end benefits sooner. Neither approach is wrong — it reflects each state's choice about how to balance the cost between employers and workers.

It also explains why your benefit amount is based on your past wages, not on your current need. The system is insurance, not welfare. You paid in (through your employer) based on your earnings, so you receive benefits based on those same earnings. Someone who earned $20 per hour receives more than someone who earned $10 per hour, even if the second person needs the money more.

Finally, it explains why some states run out of money during recessions. The system assumes that layoffs will be temporary and scattered. When millions of people lose jobs at once, the trust fund cannot keep up, and the state must find other money or reduce benefits.

How your employer's tax rate is calculated

Each state uses a formula called the experience rating or merit rating to set each employer's tax rate. The formula looks at how many former employees of that business have drawn unemployment benefits in recent years, usually the past three to five years. An employer with few claims pays a lower rate; an employer with many pays a higher rate.

The formula also includes the employer's share of the state's total benefit payments. If the state paid out $1 billion in benefits last year and your employer's former workers received $1 million of that, your employer's share is 0.1 percent. This is added to a base rate set by the state.

New employers do not have a history, so they pay an average rate for their industry. After three to five years of payroll history, the state recalculates and adjusts the rate up or down based on actual claims. This is why a business that lays off many workers will see its unemployment tax bill rise noticeably in the years that follow.

What happens when the trust fund goes negative

A few states have allowed their unemployment trust funds to go into deficit — meaning they owe more in benefits than they have collected in taxes. This usually happens during severe recessions when layoffs are massive and sustained. When this occurs, the state has three options: borrow from the federal government, raise employer tax rates when ready, or cut benefit amounts.

Most states borrow from the federal government first, then repay the loan over several years by raising employer tax rates. This spreads the cost across multiple years rather than hitting employers with a sudden large tax increase. However, it means employers in that state will pay higher taxes for years after the recession ends, even as the economy recovers.

A few states have cut benefit amounts or shortened the benefit period instead of raising taxes. This reduces the when ready cost to employers but means workers receive less support during the next recession. Each state makes this trade-off differently based on its political priorities.

Frequently Asked Questions

Does the federal government pay any unemployment benefits?

No, not in normal times. Regular weekly unemployment benefits are paid entirely by state programs funded through employer payroll taxes and state revenue. The federal government has created temporary programs during national emergencies — like the pandemic in 2020 — but these are not permanent. When those programs end, regular state benefits are all that remains.

Can an employer reduce my unemployment benefits by paying less into the system?

No. Your benefit amount is based on your past wages, not on how much your employer paid in taxes. An employer cannot negotiate a lower tax rate in exchange for lower benefits to their workers. The tax rate is set by state formula based on the employer's layoff history, and the benefit amount is set by state law based on your earnings.

If I worked for multiple employers, who pays my benefits?

All your employers contribute to the same state unemployment fund, so technically the fund pays you. However, the state may charge the benefit cost back to your most recent employer, or split it among all employers you worked for in the base period. The rules vary by state. You receive the same benefit amount regardless of how the cost is allocated among employers.

What happens if my employer goes out of business?

You can still receive unemployment benefits. The money comes from the state trust fund, not directly from your employer. The state has already collected the employer's taxes while the business was operating, so the fund has the money to pay you. If the employer owed back taxes, the state may pursue collection, but that does not affect your benefits.

Why do some states have higher unemployment taxes than others?

State tax rates depend on the state's unemployment rate, the size of the trust fund, and the state's choice about benefit amounts and duration. A state with high benefits and a long benefit period needs higher taxes to fund them. A state with lower benefits can charge lower taxes. There is no single "correct" rate — it reflects each state's policy choices.