|In reply referto
FILE. 13: D:
|FEDERAL SECURITY AGENCY
SOCIAL SECURITY BOARD
WASHINGTON, D. C.
BUREAU OF EMPLOYMENT SECURITY
July 31, 1940
T0: ALL STATE EMPLOYMENT SECURITY AGENCIES
Standards for the Interpretation of
Section 1602 (a)(1)
of the Internal Revenue Code
Enclosed is a copy of Employment Security Memorandum No.9, "Standards for the Interpretation of Section 1602(a)(l) of Internal Revenue Code," which has been adopted by the Social Security Board as a guide for the Bureau of Employment Security in its review of State laws having pooled funds or partially pooled accounts, for the purpose ofdetermining whether reduced rates to such funds or accounts are permitted only in accordance with the requirements of thatSection and thus meet the conditions for additional credit allowance under Section 1601 (b) of the Internal Revenue Code.
This statement of "Standards" covers specially the following aspects of Section 1602(a)(1): (1) the factors which may be used for the measurement of an employer's experience with respect to unemployment risk; (2) the requirement that reduced rates may be granted only on the basis of an employer's experience; and (3) the requirement that reduced rates may be allowed only on the basis of experience during not less than the 3 years immediately preceding the computation date. The Section is also interpreted in relation to the purposes of Title III of the Social Security Act and Unemployment Tax Act, to the effect that State statutory provisions for reduced rates must afford reasonable assurance that the benefits provided in the State law can be financed over a reasonable period of time.
The Social Security Board would like to call the attention of the State agencies to the fact that, while factors may be used for the measurement of an employer's experience with respect to the unemployment risk of his individual workers which measure only the frequency with which an employer's workers suffer unemployment, the Board is of the opinion that measure of severity (or duration) of unemployment as well as its frequency is desirable if reduced rates are to reflect adequately and employers experience.
Federal Security Agency
Social Security Board
Bureau of Employment Security
STANDARDS FOR THE INTERPRETATION OF SECTION 1602(a)(1)OF THE INTERNAL REVENUE CODE
Employment Security Memorandum No. 9
Unemployment Compensation Division
STANDARDS FOR THE INTERPRETATION OF SECTION
OF THE INTERNAL REVENUE CODE
AS ADOPTED BY THE SOCIAL SECURITY BOARD JUNE 28, 1940
Section 1602(a)(1) provides:
"(a) State Standards.--A taxpayer shall be allowed an additional credit under section 1601(b) with respect to any reduced rate of contributions permitted by a State law, only if the Board finds that under such law--
"(1) No reduced rate of contributions to a pooled fund or to a partially pooled account, is permitted to a person (or group of persons) having individuals in his (or their) employ except on the basis of his (or their) experience with respect to unemployment or other factors bearing a direct relation to unemployment risk during not less than the three consecutive years immediately preceding the computation date;"
Implicit in the interpretation of Section 1602(a)(1) of the Internal Revenue Code is the principle that any experience-rating plan must be designed to accomplish, through differentiation of rates as between employers, one or both of the only known objectives of experience rating, namely the promotion of stability of employment and/or a fair allocation of the costs of unemployment compensation. The Board has also accepted as axiomatic that, since unemployment compensation legislation insures the worker against the risks or hazards of unemployment--hazards which are his rather than the employer's--the terms "unemployment" and "unemployment risk" refer to the unemployment or the unemployment risk of insured individual workers and the reference in the section to an employer's experience with respect to these is to the employer's experience with respect to the unemployment of workers who are or have been employed by him or to his experience with other factors directly related to his workers risk of unemployment.
In the light of these fundamental principles the Social Security Board adopts the following standards as being consistent with Section 1602(a)(1) of the Internal Revenue Code. These interpretations will be applied in determining whether the basis, upon which reduced rates to a pooled fund are permitted under a State unemployment compensation law, meets the "State standards" prescribed in section 1602(a)(1).
Interpretation of the Phrase "other factors directly related to unemployment risk"
Since the unemployment of the worker is the basic phenomenon which is to be measured in any formula for the computation of reduced rates of contribution to a pooled fund, the factors referred to in section 1602(a)(1) are limited to those basic elements which may reasonably be counted for the purpose of establishing the frequency or the frequency and severity of an employer's experience with the impact of unemployment upon his workers. For the purpose of determining the relative significance of the employer's experience, it will of course be necessary to relate such experience to the pay roll or other measurement of exposure.
The following types of experience now found in State laws or proposed by State agencies constitute factors directly related to unemployment risk of workers, in that measurement of such experience reflects the frequency or the frequency and severity with which the worker of any given employer suffers the impact of unemployment: benefit payments, separations, compensable separations, and benefit wages. Experience with any of the foregoing reflects the basic element, the unemployment of the individual worker. Separation is only another name for the initial impact of unemployment upon the individual worker. Compensable separations limit the type of separation counted to those compensable under the unemployment compensation law; benefit payments are compensable separations weighted by the duration of compensable unemployment; and benefit wages are compensable separations weighted by the worker's base-period wages. Of these factors, benefit payments alone give some reflection of the severity as well as the frequency of the impact of unemployment. Weeks or other periods of unemployment are not at present used as factors in any State law but they also would reflect severity as well as frequency.
Some doubts have been expressed as to the reasonableness of any measure of the risk of unemployment of the worker which does not include the element of the duration or severity of the unemployment. The Board, however, takes the position that it is neither feasible nor possible to measure completely the full risk of unemployment and that separations, compensable separations, and benefit wages, as well as benefit payments, are factors which will permit a reasonable measurement of an employer's experience with respect to the unemployment risk of his workers.
The Board therefore adopts the following interpretative standard with respect to factors which may be used for the measurement of an employer's experience with respect to the unemployment risk of his individual workers.
Under the requirements of section 1602(a)(1), reduced rates may be permitted only on the basis of an employer's experience with respect to the impact of unemployment upon individuals who are or have been in his employ; such impact would be reflected by such a factor as benefits, separations, compensable separations, weeks or other periods of unemployment, or benefit wages, or a combination of such factors.
Interpretation of the phrase "except on the basis of his (or their) experience"
Rate differentials are essential to any system under which an employer's rate is based on his experience, because only by the use of differentials is there a genuine reflection of the individual experience of an employer. Within the limits of the maximum and minimum rates, the smaller the intervals between the variant rates, the greater the effect of the individual experience upon the rate which any given employer must pay, i.e., the more nearly is his rate based on his experience with unemployment or other factors bearing a direct relation to unemployment risk. Numerous differentials make the transition from one contribution rate to another more equitable because, if the interval between contribution rates is small, inequities to borderline employers are less than under a system in which the intervals are larger. In other words, using a larger number of different contribution rates, with smaller intervals between such rates, should prevent slight variations in employer experience from resulting in large variations in rates assigned to different employers with nearly the same relative experience. Moreover, there may be greater incentive for stabilization if the transition from one rate to another is more possible in a relatively short period of time.
On the other hand, administrative considerations indicate the desirability of some limitation on the number of differentials within the limited span of the maximum and minimum rates and it is recognized that the number of reduced rate classes which a State experience-rating system should provide, in order to assure suitable reflection of the relative unemployment experience of different employers, may depend on the degree of favorable experience required of an employer under the State law before he can qualify at all for a reduction below the standard contribution rate.
Although the degree of favorable experience required is not specified in terms as explicit as the standards established in section 1602(a)(3) with respect to laws of the reserve type, there is necessarily implied in section 1602(a)(1) (in order that the fund be maintained for its purpose of paying benefits) a minimum standard to the effect that there must be a favorable relationship between the individual employer's contributions and the benefits attributable to him as a prerequisite to any rate reduction.
A system of rate variations cannot be recognized as a bona fide experience-rating system, based upon each employer's experience with unemployment or other factors bearing a direct relation to unemployment risk if that system permits an employer to pay a reduced rate which is inconsistent with his experience, such as a reduced rate granted an employer even though his workers, on the basis of wage credits earned with him, had received a larger amount in benefits than the amount such employer had paid in contributions. Specifically, a reduced rate could be considered inconsistent with an employer's experience if allowed under the following or substantially similar circumstances:
(a) In case such experience is measured by an account reflecting contributions credited and benefits charged to him for a period of not less than the three years immediately preceding the computation date, if such account, as of the computation date, fails to show an excess of contribution credits over benefit charges; or
(b) In case such experience is measured by some other factor related to unemployment risk, if the reduced rate granted to an employer is not calculated to at least maintain or restore a balance between his contributions and the amount of benefits allocated to him on the basis of his experience with the measured factor or factors during the relevant experience period.
To insure, therefore, that reduced rates shall be granted only on the basis of an employer's experience, the Board adopts the following interpretative standard:
Under the requirements of section 1602(a)(1) provision must be made for rate differentials, between the law's minimum rate and maximum rate, which reasonably reflect variations of the experience of individual employers with respect to unemployment or other factors directly related to unemployment risk and no reduced rates may be permitted an employer unless consistent with such employer's experience.
The requirement that the reduced rate must be based on an employer's experience necessitates the maintenance of the influence of that experience in the determination of the reduced rate to be granted to any employer. Problems arise as to the degree to which the measurement of an employer's experience with respect to unemployment or to other factors bearing a direct relation to unemployment risk may be subjected to adjustments, by the application of other factors which bear no relation to an employer's experience, without destroying the significance of the individual experience of the employer.
A general factor designed to replenish drains upon the fund or to prevent the fund from falling below a prescribed minimum level may require a secondary adjustment in rates which results in a more limited range of rate reductions than would otherwise be accorded. Such an adjustment merely subordinates the operation of the experience-rating plan to a more fundamental objective of any unemployment insurance system: the maintenance of a fund adequate to pay benefits. However, when a factor unrelated to the employer's individual experience serves to relax the conditions for reduced rates, the reduced rate of an employer as finally computed may be determined primarily by the general factor and therefore cannot be said to be based upon his individual experience. In order to insure that the individual employer's experience is the basic determinant of his reduced rate, the Board adopts the following interpretative standard:
Under the requirements of section 1602(a)(1) reduced rates may not be permitted when the influence of the basic experience factor has been sb impaired by combination with factors unrelated to the employer's experience that such employer's own experience is no longer the basic determinant of such employer's reduced rate.
Interpretation of the phrase "during not less than the three consecutive years immediately preceding the computation date"
Under section 1602(a)(1) the reduced rate under the State law must be based on the employer's experience of the type described above during not less than the three consecutive years immediately preceding the computation date. Recognition of the fact that an employer's experience with unemployment or with a factor directly related to unemployment risk might differ radically from year to year was the basic reason for this minimum three-year requirement. Any period of less than three years could not be considered representative as a measure of an employer's experience. The factors used for the measurement of experience during the three-year period need not be identical for each of the years but one or more of the factors must be used with respect to each year.
In order therefore to insure the maintenance of the three-year requirement, the Board adopts the following interpretative standard:
Under the requirements of section 1602(a)(1) the experience upon the basis of which the reduced rates are calculated must be actually measured for the entire period of three or more consecutive years immediately preceding the computation date. Such factors need not be the same factors throughout the experience period and one or more of the factors used during a part of the experience period may be translated into terms of another factor or factors used during another part of the experience period, providing such translation is made in accordance with proper statistical procedures reasonably calculated to prevent distortion of the translated factor.
Interpretation of Section 1602(a)(1) in Relation to the Purposes of Title III of the Social Security Act and the Unemployment Tax Act
The primary purpose of Title III of the Social Security Act and of the Federal Unemployment Tax Act is to encourage the establishment and maintenance of State systems of unemployment compensation. The intent of Congress in this respect might be defeated if any part of those acts were interpreted without regard to the fundamental purposes of the acts as a whole. The solvency of a State's unemployment fund over a reasonable period of time is essential to the maintenance of any State unemployment compensation system. While section 1602(a)(1) and section 1602(c)(2) and (3) do not specifically contain any language in terms of the solvency of the State fund, the provisions of the two acts, viewed as a whole, clearly indicate that maintenance of the unemployment compensation system as such is the consideration which Congress intended should underlie the conditions for grants, normal tax credits, and additional credits, regardless of the particular type of fund or account set up in the State law.
For this reason, section 1602(a)(1) must be interpreted to prevent certification of a State law which, in the guise of providing for reduced rates based on each employer's experience, provides for rates of contributions at a general level, so low as to invite insolvency of the State fund and consequent inability of the State to pay the benefits provided in the State statute for eligible unemployed individuals. While it is recognized that assurance of permanent solvency cannot be guaranteed, nevertheless it is consistent with Congressional intent that the unemployment compensation law as a whole must contain provisions assuring that the benefits provided for in the State law will be financed for a reasonable period of time. The Board consequently adopts the following interpretative standard for the construction of subsection 1602(a)(1) as a whole:
State statutory provisions for reduced rates of contributions meeting the requirements of section 1602(a)(1) of the Internal Revenue Code must afford reasonable assurance that the benefits provided in the State law can be financed over a reasonable period of time.