California Sends SMEs the COVID Bill
There is a tax that most California employers did not choose, did not cause, and cannot avoid. It is applied to the first $7,000 of each employee's wages. And it is about to cost nearly nine times more than in any other state in the country. This is not a legislative proposal under debate. It is the arithmetic result of a federal unemployment debt that California accumulated during the pandemic and which, unlike almost every other state, it has not paid.
The figure circulating in the most recent reports ranges between $20 billion and $23 billion. The federal mechanics are simple: when a state fails to settle its debt with the Federal Unemployment Insurance Fund (FUTA), the central government automatically raises the tax rate paid by employers in that state. The pace is annual. The rate rises as long as the debt exists. California has been on that path for several years and is approaching a 5.2% federal rate — compared to the standard 0.6% paid by businesses in states that cleared their debts.
State Senator Brian Jones introduced a joint resolution asking Congress to suspend those automatic escalations. His central argument is that employers are not responsible for the debt: the state accumulated it, the state did not pay it, and now it is businesses — many of them small enterprises with minimal margins — who are absorbing the cost. The week in which Jones introduced the resolution was National Small Business Week. The timing was not coincidental.
Why the Size of a Business Determines Who Survives This Increase
Large corporations with finance teams, lobbyists, and complex tax structures have tools to manage an increase in labor costs. They can renegotiate contracts, adjust compensation structures, or distribute the impact across divisions. A business with twelve employees cannot.
99.8% of businesses in California are small enterprises. That figure, cited by Senator Jones's office, is not decorative: it defines who carries the real weight of this policy. If you take the first $7,000 of each worker's wages and apply a rate of 5.2%, the additional cost per employee exceeds $300 per year. For a family restaurant with 15 employees, that is more than $4,500 that was not budgeted. For a manufacturing company with 80 workers, the number exceeds $24,000. And if the state does not pay the debt, the rate will keep rising.
Rob Lapsley, president of the California Business Roundtable, has warned that accumulated penalties could reach $400 per employee if the problem is not resolved. That implies that the cost per employee could double or more relative to the current level, placing particular pressure on sectors with low margins and high staffing density: hospitality, retail trade, cleaning services, and elder care.
What is happening is not a tax increase designed to fund something specific. It is an automatic penalty triggered by the state's inability to settle a debt that other states managed with the same resources. Between 2021 and 2023, many states received unprecedented budget surpluses thanks to federal stimulus funds and the economic recovery. Several directed part of those funds toward paying off their unemployment debts. California chose other priorities: infrastructure, programs to address homelessness, among others. That decision was not illegal. But it has a price, and that price is now being paid by employers.
What the Unemployment Debt Reveals About the State's Risk Architecture
Fraud is also part of this story. The resolution introduced by Senator Jones estimates that California's Employment Development Department (EDD) paid at least $20 billion in fraudulent claims during the pandemic. If that figure is correct, fraud represents a substantial portion of the total debt. The federal Department of Labor announced in February 2026 that it would send a special team to investigate the abuse and management of unemployment funds in California, similar to efforts already deployed in Minnesota.
This raises a structural question about how risks are distributed in the California fiscal model. The state made decisions — extending pandemic-related closures, failing to implement sufficient anti-fraud controls, not prioritizing debt repayment during the surplus period — and the costs of those decisions are being systematically transferred onto private employers. There is no automatic accountability mechanism for the state. There is a very concrete one for businesses: the FUTA rate rises every year until someone pays.
This is not only a problem of tax burden. It is a problem of risk architecture. When an entity — public or private — externalizes the consequences of its errors onto third parties who had no voice in the original decisions, it destroys the correct incentives. California employers did not decide to extend the closures. They did not design the EDD's controls. They did not allocate the budget surplus. But they are the ones receiving the bill.
Senator Jones's resolution seeks to have Congress interrupt that penalty mechanism when the debt is the result of specific state decisions — such as forced closures or failures in fraud prevention — rather than an inevitable structural economic crisis. It is a proposal with sound logic, but one that depends on federal political will at a time when Congress's priorities lie elsewhere.
The $180 Million Tax Credit Does Not Change the Underlying Arithmetic
One day before Jones's resolution was introduced, Governor Newsom announced $180 million in tax credits through the California Competes Tax Credit program, distributed among 17 companies in sectors such as aerospace, advanced manufacturing, battery storage, and film production. The state projects that these companies will generate 4,489 jobs with an average salary of $132,000 per year and will mobilize close to $1 billion in private investment.
The numbers look solid on paper. The problem is scale. The 7.6 million jobs sustained by small businesses in California cannot be protected by selective credits for 17 companies in high-value sectors. The California Competes program has existed for years and has a logical purpose as a tool for attracting strategic investment. But it is not designed to offset a horizontal tax burden that affects all employers regardless of their sector or size.
Put another way: the state is designing a targeted attraction policy for large firms while the base of the business ecosystem absorbs a cost increase it did not choose. That is not necessarily an intentional contradiction, but it is an asymmetry of benefits that reveals how available fiscal instruments are prioritized. Selective credits require beneficiary companies to meet employment and permanence commitments. The FUTA rate asks nothing: it collects itself.
The governor's revised budget proposal — which includes a suspension of net operating loss deductions and restrictions on research and development credits that could mean an additional $4.5 billion in tax burden for businesses — worsens the outlook. If that proposal moves forward, California businesses simultaneously face the FUTA increase, the potential elimination of tax shields they used to manage years of losses, and the uncertainty of a debt that the state has no committed timeline to settle.
The Bill Is Not Only Fiscal — It Is About Who Absorbs the Uncertainty
The true cost of this situation is not only in the dollars per employee. It lies in what that kind of uncertainty does to the investment decisions of small business owners.
A business owner with 20 employees who plans to hire three more people over the next 12 months must make a labor cost projection that includes a variable they do not control: how much the FUTA rate will rise next year if California does not pay. If they cannot model that number with confidence, the rational incentive is to postpone hiring. Or not to hire at all. The result does not appear in any unemployment data as a policy decision. It appears as a slowdown in a business's growth, as a shift left uncovered, as an expansion that never happened.
This is what makes this situation particularly costly for the California economy in the medium term: it does not generate an immediate, dramatic, and visible impact. It generates accumulated friction in thousands of small decisions that together slow down the job-creation capacity of the business ecosystem. The businesses that survived pandemic-era closures, that maintained payrolls when they had no customers, that served as the backbone of their communities during the hardest moments, are now the ones carrying the cost of the state's fiscal mismanagement.
Jones's resolution faces an uncertain path in Congress. The debt will keep growing. The FUTA rate will keep rising. And every year that passes without resolution, more small employers incorporate that cost as permanent and adjust their growth plans accordingly. What began as a state liquidity crisis during the pandemic has become a hidden tax on the job-creation capacity of the sector least equipped to absorb it.
