Talk about a bitter irony.

Thanks to the tanking economy and past benefit hikes, the state’s system for providing unemployment benefits is insolvent. And the fix that state lawmakers are considering is to dramatically raise the taxes employers pay into the system.

The irony: That could force companies to lay off employees.

Take, for example, Steve Diels, who owns a Redondo Beach call center. Any tax increase could force him to fill out some pink slips.

“Right now, my profit margin has slipped and I’m doing everything I can to avoid laying anyone off,” said Diels, a Redondo Beach city councilman who employs 38 people at Aamcom Inc. “But if they increase the unemployment tax, employers like me will have to lay people off and that will only make things worse with the unemployment fund.”

Indeed, it is the surge in layoffs over the last six months with 550,000 people being added to California’s jobless rolls that has taken an unemployment insurance system on the brink and pushed it into insolvency, months ahead of state projections. Only a massive, but temporary, infusion of federal stimulus funds and loans has prevented its collapse.

California lawmakers are considering several bills to rescue the system, including a pair that would sharply increase taxes levied on employers.

“We’re talking about a $4 billion to $6 billion tax increase on employers to bring the fund back into balance,” said Michael Shaw, legislative director for the California Chapter of the National Federation of Independent Business.

Shaw said that the possible combination of this tax increase, sales and income tax hikes enacted as a part of last month’s budget deal and rising workers’ compensation premiums would slam the state’s small businesses as they grapple with the worst recession in decades.

Bert Seneca, general manager of the Beverly Garland Holiday Inn Hotel in North Hollywood, agreed, noting a state board recently recommended a 24 percent hike in workers’ compensation premiums. The hotel has about 100 full-time employees.

“Any increase in taxes is detrimental to the business climate, especially in this recession,” Seneca said. “What’s more, this comes when an increase in workers’ compensation rates could also hit us.”

New Deal roots

Ironically, the unemployment insurance system was created in part to bolster the economy during recessions, not make a bad situation worse. Unemployment insurance was a New Deal program intended to prevent laid-off workers from slipping into poverty while boosting consumer spending during lean times. Taxes were levied on employers to set up funds in each state that would provide monthly stipends to employees who were laid off.

California also structured its system so that employers who laid the most people off got hit with the highest unemployment insurance taxes “kicking these employers when they are down,” as Shaw put it.

Moreover, the state has not been legally required to build up a reserve during good times to help fund greater demands during recessions.

For example, by 2001 when the tech boom was at its height, California’s unemployment insurance fund had racked up a surplus of $6.5 billion. Eyeing that pot of money, state lawmakers voted to nearly double benefit payments to unemployed workers, to a maximum of $450 per month. But when the dot-com bubble burst and recession ensued, the unemployment fund plunged toward insolvency.

To prevent a collapse, California regulators pushed the employer tax levy to the highest level allowed by law and added a 15 percent surcharge in 2004. The fund never fully recovered; the tax rate was never lowered and the surcharge remains.

The tax rate is now at the maximum 6.2 percent of the wage base, which is defined as the first $7,000 of each employee’s wages. However, each employer’s final bill goes up or down depending on its history of filing claims.

Off the mark

State officials now admit that their last unemployment insurance fund forecast in October is seen as wildly optimistic since it assumed a statewide unemployment rate averaging 6.5 percent this year, slightly above the historical norm. As a result, the insurance deficit at the end of 2009 was projected to be $2.4 billion, what might be considered the program’s “structural” deficit.

But many more workers are being laid off. As of last month, the unemployment rate stood at 10.5 percent and many economists now expect it will be nearly 12 percent by the end of the year.

A new unemployment insurance fund forecast is due out in May and it’s expected to show the fund having a deficit approaching $4 billion.

A one-time infusion of $3 billion in federal stimulus dollars has put off the day of reckoning at least for a few months. Last week, the state Legislature voted to use the money to fund a 20-week extension of unemployment benefits for most recipients, to a maximum of 79 weeks. Some of the money would also be used to plug the fund’s deficit.

But the federal dollars don’t address the unemployment insurance fund’s long-term imbalance. Last fall, Gov. Arnold Schwarzenegger called a special session of the Legislature to address this issue, saying it was essential to rein in some of the system’s costs and take other steps to bolster revenues.

Two bills have emerged that would increase the employer tax levy and have drawn employer opposition: SB 222 by Sen. Denise Ducheny, D-San Diego, and AB 1298 by Assemblyman Joe Coto, D-San Jose.

Both bills increase the base wage level that is eligible for taxation, from the current $7,000 of an employee’s wages to either a maximum of $16,000 or $21,000, effectively doubling or tripling the total amount employers would pay. Coto’s bill also indexes the taxable wage base to inflation and increases the tax rate of 6.2 percent to as much as 7.5 percent.

“These tax increases would hit every employer, regardless of whether they have made any layoffs,” said Jason Schmelzer, lobbyist for CalChamber, formerly the California Chamber of Commerce, who called the proposed tax hikes a case of “bad timing.”

Seeking cost savings

Schmelzer and other business lobbyists say they want to see more cost savings enacted, such as raising the income level or hours worked before workers are eligible for the benefit. Other savings could come by holding telephone hearings on employee appeals of benefit denials, instead of requiring in-person appearances.

Some also would like to see some of the benefit increases enacted in 2001 rolled back, but in a Democrat-controlled Legislature, that is viewed as highly unlikely.

Labor union representatives have proposed their own fixes. They favor the two bills that would increase the taxable wage base from the current $7,000 per employee. But they also want to see benefits increase even more, saying that even with the 2001 increases California’s benefits still rank low nationally.

Emily Clayton, policy coordinator with the California Labor Federation, said one proposal that she hopes employers will support is restructuring how employers are taxed.

“The way it works right now, the highest tax rates are imposed when the fund is the weakest, which is when the economy is the weakest,” she said. “We’d like to see a system where taxes on employers are raised in good times and then rates are cut when more workers are being laid off.”

But Diels, the call center president, said he doesn’t want to see employer taxes go up at all.

“The focus is all wrong,” he said. “The folks up in Sacramento are looking at the plight of unemployed and not at the plight of employers trying to keep people from being unemployed.”