Payroll tax not helping Indiana

The Great Recession is now a full six years behind us, but many of its effects continue to linger.

One of these is in the way we pay unemployment compensation taxes, which is one of the most regressive tax burdens borne by low-income workers. To understand this, you must first comprehend one of the most byzantine federal tax programs ever devised. Let me try to explain.

The slide into the Great Recession caused well more than half of states to borrow from the federal government to help pay unemployment claims. This debt is supposed to be paid back as the economy recovers. Indiana will be able to pay off that debt sometime next year, but there is a catch.

Businesses are levied a tax to pay off this debt, but each year the state owes a balance to the federal government causes the businesses in a state to face an escalating tax. The tax grows by 0.3 percent annually and so in 2015 it is already large. The extra tax stops once the amount is paid off, but there’s another catch.

Businesses pay these federal taxes, which are different from the state unemployment taxes most of us are familiar with. The federal tax levies a flat rate on the first $7,000 earned by each new employee, each year.

The state tax levies a tax based upon an insurance-like formula to collect money from firms that are more likely to lay off workers. Firms that rarely lay off workers pay much lower rates. That means the federal tax has two problems the state taxes don’t.

Though businesses pay the tax administratively, it is the workers, not the businesses, who actually bear most of the burden of this tax through lower wages or fewer working hours. This is called the “incidence” of taxation.

The reason for this is that the state tax is levied more heavily on firms that frequently lay off workers, and these businesses tend to have a more specialized, better-compensated labor force. That makes them less likely to get stuck with the cost of the tax and more likely to benefit from it down the road. But that isn’t the only problem; the tax is unfair in more fundamental ways.

The federal unemployment tax is a flat tax on the first $7,000 of income. So, a retail worker making $10 an hour pays twice the share of his income as a manufacturing worker who makes $20 an hour.

Indiana can end this federal tax in 2015 by paying off the debt early with general fund reserves. We’ll still have to build up our unemployment trust fund reserves.

But, by my estimate, paying off this debt early will add something like 5,100 jobs and $220 million of Hoosier incomes in 2016. More importantly, it’ll eliminate one of the most regressive taxes now facing low-income workers in Indiana.

Michael Hicks is the director of the Center for Business and Economic Research and an associate professor of economics in the Miller College of Business at Ball State University. Send comments to