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Back-Door State Debt Relief Looks Dubious for Passage

I touched on the Obama plan to forgive some interest payments from the states, but it deserves a bit more. Because this is a recognition in the budget that states still have a tough road ahead. While state revenues have begun to pick up, they still face a near-term deficit of over $125 billion, according to the Center for Budget and Policy Priorities. And they owe the federal government $42 billion in borrowed money to pay for unemployment benefits, which have shot up during the jobs crisis.

So the Obama budget will have a two-pronged approach. One, it would forgive interest that the states would have to pay in the near term for two years. This would forgive about $3.6 billion in debt, which would have hit employers across the country, because that’s how money is raised for unemployment insurance funds. Then, the Administration would eventually increase the taxable income level for unemployment insurance. Under current rules, employers pay federal taxes on the first $7,000 of income for unemployment; under the new rules, they would pay $15,000. This extra revenue would then be passed to the states, which can keep it, or return it to employers. So federal unemployment revenue collection would not increase, but the states would essentially be given the ability to raise taxes. This would also be held off for two years but phase in starting in 2014.

Pete Davis considers this “slick fiscal policy” but says that House Republicans would never allow such a back-door tax increase, although some Republican Governors would love to have the money to reduce the debt burden of their unemployment insurance funds. And indeed, Republicans in Congress are not impressed.

“I strongly urge the White House to reconsider this job-destroying proposal,” Sen. Orrin G. Hatch (R-Utah), the senior Republican on the Senate Finance Committee, said in a statement. “Either employers will have less money to hire or workers will face reduced wages. Neither makes any sense and runs counter to our shared goal of getting the American people back to work.”

Rep. Dave Camp (R-Mich.), chairman of the House Ways and Means Committee, said the plan “isn’t going anywhere in the House.” He added, “We need to reform our unemployment programs, [but] employers are demanding reforms to the unemployment program, not higher taxes on job creation.”

I could see the moratorium being adopted, which even state Chambers of Commerce seem to support, without the tax increase on the back end. That would transfer some state debt to the federal deficit, but surely Republicans would look to pay for that somehow, with cuts elsewhere in the budget. So at the end, we’d have a proposal that forgives a necessary tax increase to replenish state unemployment funds, and reduces fiscal demand overall in the economy.

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David Dayen

David Dayen