California’s thorough bungling of unemployment insurance system

The fight is on to shift the blame for California bungling the processing of unemployment insurance claims so badly that the state lost at least $11 billion, and maybe as much as $31 billion, to fraud.

On Tuesday, state officials announced the appointment of a special counsel to assist in the investigation into fraudulent unemployment claims that resulted in mind-boggling sums of money flowing to international criminal organizations, swindlers and even prison inmates.

Mcgregor Scott, who will have the title, “fraud special counsel,” is a partner at the law firm King & Spalding. He was the U.S. Attorney for the Eastern District of California, where he oversaw investigations into fraudulent unemployment claims until he stepped down in February.

Now Scott will oversee a task force of state and local law enforcement agencies, which was set up by Gov. Gavin Newsom in November.

While it’s appropriate to direct resources to prosecuting those who engage in illegal activity, the problem in California may be due to the actions of government.

A CNBC investigation found that California suffered from a disproportionately large amount of transaction fraud because the state chose to distribute unemployment benefits using debit cards that did not have a chip embedded in them. Security experts say cards that have only a magnetic stripe, like the ones California used, are easy for criminals to copy.

On the other hand, Hawaii directly deposited funds into recipients’ bank accounts, and there were only “negligible instances of stolen funds,” CNBC’S analysts found.

The U.S. Department of Labor estimated in January that “improper payments” of unemployment benefits totaled nearly $40 billion nationwide. Most of that fraud involved identity theft, which was a significant problem in California. EDD officials seemed to have found a way to approve claims for fraudsters without verifying identity at the same time they were freezing the benefits of legitimate claimants.

Whether genuine or fraudulent, the transactions on unemployment debit cards were lucrative for the Employment Development Department. Thanks to a 2011 contract with Bank of America to replace paper unemployment checks with debit cards, the merchant transaction fees paid whenever those cards are used are split between B of A and the EDD. Calmatters reported that in September 2020, the EDD collected $5.2 million from debit card transaction revenue.

Perhaps the new “fraud special counsel” should investigate the state for conflict-of-interest, bureaucratic incompetence and inadequate technology. Incidentally, Bank of America has said it would like to get out of the contract as soon as possible, but the state has picked up the option to renew it.

The cost of the unemployment fraud will be pushed onto the businesses that pay unemployment insurance premiums for their employees. The state’s unemployment insurance fund is now roughly $22 billion in debt to the federal government, and state lawmakers have taken no action to pay down that debt despite a windfall budget surplus and unprecedented federal aid.

The California Chamber of Commerce points out that every year the UI debt is not paid off, the per-employee tax paid by employers will increase, reaching as high as $420 per employee.

That’s a good way to discourage hiring, drive more companies out of the state, and cause even more unemployment.

It’s fine to hire a special counsel to investigate fraudsters who stole unemployment benefits, but there’s plenty of blame to go around.