Statement of Dan Blankenburg, Manager, Legislative Affairs,
National Federation of Independent Business

Testimony Before the Subcommittee on Human Resources
of the House Committee on Ways and Means

Hearing on the President's Unemployment Administrative Financing Reform Initiative

March 5, 2002

On behalf of the 600,000 members of the National Federation of Independent Business (NFIB), I appreciate the opportunity to present the views of small business owners on the subject of reforming the nation’s unemployment system.

NFIB represents small employers.  Our typical member has five employees and reports gross sales of around $350,000 per year.  Our average member nets $40,000 to $50,000 annually.  While there is no benchmark used to define a small business, our membership is very much a reflection of American small business when compared to data compiled by the United States Census Bureau.

We believe it is important to distinguish the type and size of businesses NFIB represents.  Too often, federal policy makers view the business community as one monolithic enterprise that is capable of passing taxes and regulatory costs onto consumers, without suffering negative consequences.  For small business this is not the case.  NFIB members are not publicly traded corporations; they are independently owned and operated.  They do not have payroll departments, tax departments and attorneys on staff.  Being a small business owner means, more times than not, you are responsible for everything—taking out the garbage, ordering inventory, hiring employees, and dealing with the mandates imposed upon your business by the federal, state and local governments.  That is why simple government programs, particularly when it comes to the tax code, are so important.  The less time our members spend with “government overhead,” the more they can spend growing their business and employing more people.

Growing businesses lead to job creation, which is one of the major roles small business plays in our national economy.  Small business is the leader in job creation because it is the embodiment of the entrepreneurial spirit.  Small firms with fewer than 500 employees employ 52 percent of the non-farm private sector work force as of 1998, and are responsible for 51 percent of the private sector business share of the nation’s gross domestic product.   From 1994 to 1998, about 11.1 million new jobs were added to the economy.  Small businesses with 1-4 employees generated 60.2 percent of the net new jobs over this period and firms with 5-19 employees created another 18.3 percent.  It is because small businesses have such deep impact on employment and the national economy that we feel it is critical that the policies you shape account for the impact the law will have on small business.

Year after year, NFIB researchers have found that the two biggest challenges facing small businesses are health care and taxes.  Our members are overwhelmed by the complexity of the tax code and their responsibilities, not just for income taxes, but also for the variety of federal and state payroll tax filings—including federal and state UI.  They very much want to comply with the law, but its sheer size makes understanding the law nearly impossible for the average business owner.  NFIB strongly supports efforts to simplify and cut taxes for our small business owners, and that is why we are pleased to testify on the Administration’s proposals in this area.  In our opinion, the federal unemployment system is ripe for reform.

The Current System

The Unemployment Insurance (UI) system is a joint state-federal program, created with the passage of the Social Security Act of 1935.  The Federal Unemployment Tax Act (FUTA), contained within the U.S. Internal Revenue Code, effectively mandates that the states maintain an unemployment insurance program in conformity with certain federal requirements.  The UI system is financed by two taxes levied on employers--one state and one federal.  The state UI tax is used to fund unemployment compensation benefits.  The State tax is experience rated, meaning that an employer’s tax rate is based upon past incidence of successful unemployment claims by his or her employees.  The federal tax is a flat-rated tax, levied on a $7,000 taxable wage base.  The federal tax is used to fund: (1) state and federal administration of the system; (2) the 50% federal share of extended benefit costs; and (3) loans made available to states when their trust funds are depleted.

Both state and federal UI taxes are housed in the federal Unemployment Trust Fund, which is part of the unified federal budget.  Each state has its own account in the federal trust fund into which state taxes are deposited and out of which state benefits are paid.

State unemployment compensation benefits are an entitlement and are not subject to the appropriations process, but administrative funds are appropriated by Congress and distributed to states through grants from the Department of Labor.  For many years state UI agencies have complained that the Congress is under funding administration of the program in order to mask the size of the federal deficit or to spend the dollars through the appropriations process.  States have responded to this funding shortfall by reducing services to claimants, and in many cases enacting separate new taxes on employers to fund administration of the program.

For small business, FUTA presents several problems.  First, the rate is too high.  Often we hear from critics that cutting this tax will do little for small business owners since the cost per employee is “only $56 per year.”  I would ask the Committee to consider that the average NFIB member has five employees and that we have 600,000 members nationally.  In our association alone, reducing the FUTA tax, as the Administration proposes, would result in over $126 million that would remain in the hands of entrepreneurs.  While the difference between a .8% tax and .2% tax sounds small, our average member (with an annual income of $40,000-$50,000, five employees) would save $210 annually under this proposal.  I would further point out that there are approximately 17 million full-time, self employed people in the country today.  If they were all average NFIB members with five employees, this tax savings would represent roughly $3.57 billion annually.

Second, under the current system, employers are required to pay two unemployment taxes – the federal tax and the state tax.  That means twice the collection points, twice the payments, and twice the complexity.  Payroll taxes were listed as the most costly tax in an NFIB tax survey, just ahead of personal income taxes.  And 53 percent of those surveyed said payroll taxes are less fair or much less fair than business income taxes.

Third, the taxes raised for UI programs are raided for deficit reduction or spent on other federal government endeavors other than UI programming.  This fact, perhaps more than any other, infuriates small business owners.  Like the American consumers’ desire to see gas tax revenues spent on transportation, NFIB members desire all UI taxes to be spent on UI programs or be sent back to them to use in their business.

Finally, when considering the cost and impact of the FUTA tax, it is important to remember that the federal FUTA tax is not the only tax on payroll for which small business owners are responsible.  In addition to federal FUTA taxes, the business owner is paying State FUTA taxes and federal Social Security and Medicare taxes.  In addition the business owner is responsible for the cost of filing quarterly state and federal payroll tax forms, making scheduled federal and state payroll tax deposits, making regular federal and state unemployment tax deposits in addition to filing the appropriate forms.  These are real costs of hiring employees, that an individual who has never had to make a payroll takes for granted, but that involve real costs to small business owners and that add up to real dollars for a small business owner.

The Administration’s Proposal

As an overall package, we are pleased with the Administration’s proposal and have included specific comments on some of its the key components:

FUTA Tax Cut

NFIB strongly supports the proposal to cut the federal unemployment tax by 75% through January 2007.  Today the federal tax is .8% and under the proposal the tax will be reduced to .2% by 2007.  This tax reduction would be particularly gratifying to small business owners because .2% of this .8% was imposed in 1976 as a temporary surtax.  Congress promised to remove this temporary tax once the loan from the federal trust fund to the States was repaid.  In 1987, the loan was paid off, but the tax remained.  Since then, the Congress has extended this tax five times.  Last year, this extension resulted in a $1.75 billion tax burden on the nations’ employers.

We also applaud the reduction to the total FUTA tax beyond the surtax because the FUTA collects far more than it needs.  FUTA raised $6.1 billion in 1998, but only $3.5 billion was spent on FUTA-related expenses.  The balance was used to pay for non-related government programs.

Streamlined Filing of FUTA Tax Forms

We are very pleased to see an effort to reduce the complexity of Form 940 in the Administration proposal by eliminating a many of the information requests and calculations in Part II that is already reported on the state UI forms.  Federal paperwork complaints ranked eighth in NFIB’s  “Problems and Priorities” survey.  The majority of paperwork coming from the federal government is tax-related, so any effort to streamline or eliminate forms or steps on forms would be welcomed with open arms.

However, we think the Administration proposal could go one step further.  Small business owners know that a great deal of time is wasted by having to provide the same information in different form to federal and state agencies. We would urge the Administration and the Congress to consider eliminating all of the overlap between the federal and state forms and simply and coordinate the filings into a combined federal state form that must only be filed once.

Reed Act Transfer

The Administration’s budget has proposed 13 weeks of additional temporary federal extensions of unemployment insurance be provided to workers.  The federal government would fund this benefit.  They have also proposed returning $9.2 billion in “Reed Act” funds to the states for expansion of benefits, or enhancements in reemployment services, shoring up trust funds or cutting employer payroll taxes.

NFIB believes returning these dollars to the State employment offices is a positive decision.  As mentioned above, the Congress has failed to spend this money on its stated purposes in the past and we do not believe this is likely to occur in the future.  This misappropriation of funds has lead to a degradation of employment programs and inefficiencies that have resulted in tax increases in some states.  We believe the taxes raised for unemployment programs should be used solely to fund unemployment programs.  In the event that the taxes raise more dollars than is needed to run the unemployment programs, the taxpayers should be refunded their dollars.  Neither the Congress nor a State Legislature should spend the surplus dollars on other programs.

Temporary 13-Week Extension

NFIB does not have a position on the 13 weeks of additional unemployment insurance.  We do believe that the temporary nature of this benefit is appropriate and that it would only become a concern if the proposal became a permanent benefit that NFIB members would be required to finance.

Triggers and State Eligibility

We also understand the Administration’s proposal reduces the “trigger” for extended benefits eligibility and would allow States to determine when extended benefits would apply.  This change will increase the number of individuals that will qualify for benefits, resulting in a higher demand on the programs in an economic downturn.  While we are not completely comfortable with these provisions, they are acceptable when viewed together with the reduction of taxes and the increased responsibilities of the State governments.  We feel that the respective State governments know their workforces best, and that they will be able to react quickly and efficiently to the demands of their workers.  Empowering the States will move the unemployed back to work quicker, result in less demand on the system and ultimately eliminate future need to impose higher UI taxes on employers.

Conclusion

In conclusion, NFIB believes that the proposal advanced by the FY 2003 Administration budget is positive.  The current system is too expensive, too complex and too unfair.  It is time we pink slip the current unemployment tax system and pass this sweeping reform plan, which will ease the tax burden on Main Street and restore some integrity to the system.  Thank you, Chairman Herger and Ranking Member Cardin, for soliciting the views of NFIB on this matter.   We look forward to working with the Congress and the Administration on these important reforms in the coming months.