Texas leaders had long known they weren't charging businesses enough unemployment insurance tax to ride out a deep, job-killing recession like the one last year.

The state was slammed with two years worth of unemployment claims in the first two months of the COVID-19 pandemic. The surge quickly drained the state's Unemployment Insurance Trust Fund.

The federal government bailed out Texas and 22 other states. The federal government paid $7 billion to cover some of the cost for out-of work Texans over the past 10 months.

The funding was not a gift. It was a loan to help pay the 9.5 million worker claims which had been filed in March. Texas will pay back the interest as it is now that the interest has begun to build up.

Officials in the State expect to make the initial payment of $12.6 Million by Sept. 30, according to officials.

To cover the debt, taxes on businesses will likely go up for years. The state has until next November before automatic increases from the federal government take effect. To avoid it, the state will likely sell government-backed bonds.

Through much of the pandemic, interest was paid on these loans by the U.S. Treasury programme Title XII -- authorized in Title XII under the Social Security Act. The floating rate of 2.27 percent began accruing on Labor Day. It's still not clear whether taxpayers or businesses -- or both -- will feel chronic underfunding's real cost.

Texas may have to take out Title XII Loans in September.

"[The Texas Workforce Commission, or TWC] anticipates it could start borrowing again in September," said James Bernsen, a spokesman for the agency in June.

The state was able cover its own unemployment claims, and stopped taking federal dollars in April 2021 because of the recovery. However, the interest is due so it is trying to reduce its September tax burden.

Bernsen explained that Title XII would be drawn once more cash is available to lower the Title XII deficit in an email this week.

Texas, in effect, is paying down its credit card balance (Title XII) to lower its payment for the month, but it will need to use the federal credit card later in the month. It seems to be quick to clear Title XII's balance.

It's not Just Texas

According to the U.S. Department of Labor, the Lone Star state was ranked 50th of 53 states or districts for funding unemployment funds in 2020. It was slightly lower than Puerto Rico and slightly higher that New York, California, or the Virgin Islands.

The federal government will start charging Texas as well as 12 other states and district interest on the $54 Billion in unpaid loans to fund unemployment insurance for the pandemic.

"This is red or blue, either one or both. California, Texas and New York are underfunding the UI funds," William Glasgall said, senior vice president for state and local initiatives at Volcker Alliance. The Volcker Alliance is a non-profit that focuses on government fiscal practices. They'll keep the money in there for a normal-type of recession. Because there's no stigma, and really no penalty involved in running a very lean operation."

Texas sits third behind New York's $9 billion and California's $23 billion when calculating which states drew the most money from the Treasury.

Most of the taxes used to fund unemployment insurance (UI), are collected from spring businesses. The state's unemployment has dropped to 6.2%, which is less than half its height before the coronavirus outbreak. However, it's almost three percentage points higher than the rate it was prior. It appears that the recent COVID increase is slowing hiring, putting at risk future Title XII Loans.

Last spring, the state suffered from high unemployment rates. It was like many others. The state used the $2 billion in its Unemployment Fund Trust Fund quickly.

TWC stated that the legislature should decide the minimum and maximum amount it collects.

The state actually collects less money now for the unemployed than it did last year. The TWC reduced the rate going towards the UI Trust Fund so it could start saving to pay off the debt from underfunding it.

TWC stated in a June press statement that "If today's Commission action had not been taken, most Texas employers would have seen substantial increases in their tax obligation in 2021."

The Texas legislature also reduced the amount businesses would have had to pay in unemployment taxes this year.

Since unemployment taxes for a business are based on how many people it let go the previous year, a very large bill was coming for most. TWC and the legislature felt that it would have been an enormous burden on businesses during this fragile time of recovery.

House Bill 7 has changed the method of calculating these bills. It gave an exemption to employers if there was a disaster declaration in effect for more than 50% of the state.

The HB 7 fiscal note stated that "no significant fiscal implication is expected for the State." "However Unemployment Trust Fund accounts, which are not owned by the State Treasury and would be subject to a deficit of $5.4 million for the 2021 and 22 tax years, is the fiscal note.

Many members of the business community, struggling to stay afloat, celebrated the changes.

Glenn Hamer of Texas Association of Business said, "Right Now, the most important thing to do is to have any possible policy directed towards getting people back into work." "And taxes from businesses play a part in who is going to be in the labor force."

Wayne Vroman (an economist and senior researcher at Urban Institute) stated that the argument where the money is better left in the employer's pockets than in trust funds is the same one that kept Texas' unemployment fund underfunded.

Vroman stated, “That assertion has never really being tested by economics professions to know whether it's an argument that holds water."

He added that Texas is unique in its dedication to that philosophy. "No other state has been more passionate about that idea," he stated.

Unemployment insurance is a relatively low expense for employers. It costs only six tenths to a percent of the payroll. Social Security and many other payroll expenses far exceed it.

"So unemployment insurance has a price. It's not an expensive cost. And in a state like Texas, which has a low share of the unemployed who collect benefits, the costs are even below the national average," he said.

In any case, the $7 billion bill -- a result of an underinvested unemployment program -- is due.

The cost will still be paid by businesses, but it will be more with interest and other fees being used to service debt instead of going to the unemployed. This is perpetuating underfunding.

In June, Texas borrowed $1.3 billion from the U.S. Treasury. On $6.9 million, the state will owe interest at 2.27%. If those figures remain the same, the state will owe a minimum payment of $12.6 million at the end of September 2021. TWC projects that they will reduce the amount due to current UI Trust funds so that it is only $10 million.

Additionally, if Texas is in default on its debt obligations in November 2022 then the federal government will tax all Texas businesses with an automatic reduction of the Federal unemployment insurance tax credits. Each year that Texas has a balance of debt with the Treasury, this rises exponentially.

While an ongoing recession isn't the best time for taxes to be raised, it is Texas's fault in many ways. Twenty-eight additional states were able to pay unemployed residents in the aftermath of the pandemic without resorting to Title XII programs from the federal government.

What is Texas doing now? Here are some options.

CARES

First, Texas could make use of the Coronavirus Aid, Relief and Economic Security Act, a $2 trillion fund that was passed in March 2020. By and large, CARES money could not be used for debt repayment. It did however have a $150 billion fund, the Coronavirus Relief Fund, for state, local and tribal governments. This fund could be used to support unemployment trust funds and workforce development.

According to The Associated Press, 29 states indicated in May that they might tap the fund to help their UI Trust funds. It is unclear if Title XII states borrowed from this fund to repay Treasury.

The Urban Institute reports that 20 states had already used $6 billion of the fund to address unemployment and workforce development as of June. It was not known if any of this money was used to pay Title XII owed.

Vroman stated that he expects Texas to explore this idea.

The Coronavirus Relief Fund provided Texas with $8 billion. None of it went to TWC, staffers said, and it wasn't currently clear if it will be used to pay back any Title XII debt.

Federal relief dollars, which are required by law to be paid by business owners, would be used to help UI Trust funds. This would imply that taxpayers were bailing businesses out.

It could also set a negative precedent. States like Oregon and Vermont might wonder why they even bother when Texas and California pay off their debts. Vroman said that if people thought they would get money for free, and their trust funds go bust, they may be less vigilant in building trust funds.

And do Vermont cheesemakers or Oregon fisherman want to be bailing out Texas when they are already paying seven times what Texas business owners are into their state's trusts?

The precedent could lead to other states underfunding their unemployment trusts in return for more federal bailout dollars. This would also shift the burden for unemployment insurance taxes to everyday taxpayers rather than business owners.

Government Bonds

This isn't the first time Texas has been forced to pay its citizens with federal dollars. Twice before, Texas has taken out Title XII loans. Two times before, the TWC issued bonds to pay these back. The TWC had previously issued bonds to pay back $1.9 billion in 2008 during the Great Recession.

In contrast to either of these instances, the federal government wasn't offering money that could pay itself back.

The Urban Institute reports that it took the state longer to pay off debt than if it had not allowed federal taxes to increase under Title XII. But, they were able maintain lower annual payments. And because government-backed bond are so in demand that the state could offer them at a premium price, the state made a better financial decision than allowing a federal collect.

These government-backed bonds are still in high demand. If/when states decide to sell them again, they may be able sell at a premium. But it isn’t clear if these will save money.

Texas owes more than it has ever before.

To repay Title XII debentures, the state sold bonds totaling $1.9Billion in 2010. Now, the state owes nearly 3.5 times as much. TWC has not yet decided if they will follow this path.

"I think it's kinda premature to kinda make that decision, until you know where the --you know, where the field is after everything, all the dust settles," said Chris Nelson, head of TWC finance, in a commission meeting earlier this year.

The process of issuing municipal bonds involves a lot of technical work and fees. For these reasons, many other state unemployment departments did not issue them. Texas had experienced issuing them after 2000's dot-com-bust recession.

Texas also chose to issue bonds because they have more control over the repayment process. Taxes are subject to a federally mandated scheme. A bond allows them to target the most affected companies, i.e. those whose workers used the unemployment program the most. They can then make the bonds more expensive. They did this using their bonds that they had issued after the Great Recession.

The state -- in an effort to boost employer funding-- has left itself in a financial hole, owing billions to the federal government. What it does next will set precedent for future recessions, and it's very likely Texas will continue to underfund its unemployment system to pay down debt.

Meanwhile, elected leaders and state officials will hope that the state does not experience another recession.