Little did California businesses know that they were cosigners on the state’s nearly $20 billion loan from the federal government that was used to cover California’s unemployment fund shortfall during the COVID pandemic. This ugly truth became apparent when the state recently decided to stop making payments on this loan. When a state defaults on its federal unemployment insurance loan, federal law requires that the state’s businesses repay the loan.

What makes this default even more egregious is that the stone-age-era IT system of the state’s Employment and Development Department (EDD) opened the floodgates to bad actors, permitting more than $30 billion in fraudulent unemployment claims during the pandemic. Those receiving fraudulent payments include incarcerated felons, a person impersonating a one-year-old, and a person impersonating Senator Dianne Feinstein. A single residential address received checks for around 60 separate individuals filing from that address.

This could have been avoided with a competent EDD. But this department’s performance has been deficient for decades, and California businesses, many of which are struggling, are left paying for blatant and costly mistakes that should and could have been solved years ago.  

With an unpaid federal unemployment insurance loan, the federal government raises the unemployment insurance tax immediately by 0.3 percent on each business within the state, and an additional 0.3 percent each year after that until the loan is fully repaid. The normal federal unemployment insurance tax rate is 0.6 percent per year, which means that California businesses will be paying several multiples of the normal federal tax rate before the loan is retired.

The state’s Legislative Analyst Office predicts that repaying the loan through higher taxes on businesses is not expected until 2029 or 2030 and note that retiring the debt could take longer, depending on the state’s economic performance. A recession would almost certainly delay repayment, and the odds of a recession in the next seven years are significant.

The state’s decision to default is inexcusable. California recorded a nearly $100 billion state budget surplus last year, thanks to the state’s top earners, that could have been used to repay the debt. The state received $27 billion in federal COVID aid it could have used to repay the debt. The state’s record $300 billion–plus 2022–23 budget could have retired the debt. Even after defaulting, the state could have resumed its payments this year and offset the tax burden on businesses, as it planned to do in its 2023–24 budget. But as the state’s finances continue to decline, the state has walked back making payments or offsetting higher business federal unemployment insurance taxes.

Twenty-two states received federal unemployment loans during the pandemic, and California is just one of four states that have not yet repaid the debt. As of the end of last year, California owed nearly two-thirds of the outstanding $27.5 billion federal unemployment insurance debt among these four states. The other states with remaining unpaid debt are New York, Illinois, and Connecticut, all of which are high-tax and high-spending states that are all losing population to other states. I will let you draw your own inferences about why people are leaving California and these other three states and moving to states with lower taxes, fewer regulations, more economic freedom, and lower living costs.  

The EDD’s IT system is from the 1980s and runs software that is more than 50 years old. For decades, the department’s IT people tried to patch the system, but it became increasingly apparent the system was inadequate. In 2013, the EDD received a grant from the Obama administration that was used to purchase software from Pondera Systems, a business that has created extremely effective software that searches over many databases and uses proprietary artificial intelligence algorithms to identify fraud and abuse. The software, which cost about $2 million per year, was in place from 2013 until 2016. EDD employees noted that the software identified a “remarkable amount of fraud.” 

In the summer of 2016, the EDD discontinued the Pondera software. The 2013 federal grant had run its course, and the software was not renewed because of the $2 million price tag, which represented less than 1 percent of the EDD’s budget. Is anyone accountable for this decision? Did anyone in the agency fight to retain the software, given its remarkable performance? Did anyone anticipate what would happen without the software? Nearly three years later, these questions remain unanswered. Without the fraud-detection software, the EDD might as well have attached neon lights to its ancient mainframe computer, with a sign saying “The party is here! Open bar!” A $2 million dollar annual software purchase compared to $32.6 billion in fraud gives a whole new meaning to the term incompetent government.

How did state government respond to this fiasco? In July 2020, Governor Newsom appointed a “strike force” to evaluate the EDD. By September 2020, Beverly Hills police arrested individuals who were buying expensive clothing, jewelry, and cars using EDD debit cards, which electronically provide unemployment benefits. Those arrested showed the police how easy it was to obtain these cards. Rapper Nuke Bizzle penned a song about the ease of committing EDD fraud that goes like this: “I done got rich off EDD. . . . I just might swipe me a lump sum. I’m in Dior havin’ money fun. . . . Ten cards, I’m swiping 10K a day. Counting up bills like a CPA.”

The strike force’s report cited many deficiencies,, including the use of 1980s technology, employees who do not securely handle passwords, certain types of claims being dealt with manually, and the failure of having a systematic approach to even determining their backlog. But none of this is news. The EDD has been the subject of 10 audits over the previous decade, and as you can see from its recent performance, none of these previous audits has moved the needle.

Even after all this, the EDD can’t identify all the fraud that occurred. The EDD estimated about $20 billion in fraud, but Lexis-Nexis, an independent data and analytics firm, reports the fraud is approximately $32.6 billion.

The costs of California’s unemployment fraud debacle will be borne by everyone, because higher taxes on businesses means high prices, less hiring, lower raises, less investment, and less new-business formation. The state agency that is responsible for taking care of the most vulnerable Californians has been inadequate for years, and neither the governor nor the Democratic supermajority in the state legislature is willing to hold the EDD accountable.

Regarding accountability, the head of California’s labor department during the pandemic was Julie Su, who served as California’s labor commissioner between 2019-2021. She is now U.S. Assistant Labor Secretary and has been nominated by President Biden to succeed former Secretary of Labor Marty Walsh, who resigned to head the National Hockey League’s player association. Republicans, led by California freshman House representative Kevin Kiley, have opposed this nomination, and this has coordinated broader opposition to Su among business groups.

Su was confirmed as US assistant labor secretary in 2021 by only a 50–47 vote, with those opposing her citing California’s pandemic unemployment debacle that took place on her watch, and her support for California’s controversial 2020 law that makes working as an independent contractor in many occupations in California illegal. Now, as she awaits a Senate confirmation hearing to become U.S. Secretary of Labor, California’s failure to repay its federal loan has put the spotlight back on California’s awful EDD performance. Ironically, her home state’s irresponsibility will make this confirmation even more difficult than her 2021 confirmation, and perhaps impossible. Even if there is no accountability in California, perhaps there will be at the national level.

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