Earlier mistakes foreshadowed the state’s $2.5 billion unemployment accounting blunder

The mistake didn’t draw much attention at the time, in part because former governor Charlie Baker’s administration released the report on New Year’s Eve. But it was also overshadowed by another, more surprising KPMG finding: The trust fund’s balance had soared to $2.9 billion, from a deficit of $1.8 billion just six months earlier, even though the state had made massive benefit payments in 2020 and 2021.

In retrospect, the review should have set off alarm bells. KPMG found two other accounting “adjustments” totaling $678 million, but these went in the UI fund’s favor.

The consultants blamed those earlier mistakes on an extraordinary confluence of events that began in March and April 2020, when the Department of Unemployment Assistance was swamped by a tsunami of jobless claims triggered by the economic earthquake of COVID-19 shutdowns.

The DUA was also under the gun to set up a system to distribute new federal pandemic benefits to laid-off workers who didn’t qualify for state aid. And the US Department of Labor was making frequent — sometimes retroactive — rule changes for those new programs, which required the DUA, for the first time, to combine traditional state unemployment and federal aid in a single payment.

“The combination of these changes ultimately fractured the connection between operational and financial functions,” KPMG said.

The Executive Office of Labor and Workforce Development, which oversees the DUA, hasn’t explained how the recently disclosed accounting blunder — which occurred in fiscal years 2020-2022 — was made or why it wasn’t discovered until a routine audit of the state’s annual comprehensive financial report for the 2021-22 fiscal year by accounting firm CliftonLarsenAllen. The office of the comptroller released the financial report last week.

CliftonLarsenAllen’s audit of the state’s 2021 financial report didn’t uncover any issues with the UI trust fund, nor did KPMG’s audit of the 2020 report.

Messages seeking comment from CliftonLarsenAllen and KPMG were not immediately returned.

The erroneous use of federal funds won’t affect unemployment recipients, the state says, since the claims themselves were valid.

But employers, who fund the UI system through assessments on their payrolls, are worried that they will have to make up any money paid back to the federal government. That’s because if the accounting error hadn’t been made, the jobless claims in question would have been paid out of the UI trust account.

Governor Maura Healey said earlier this week that she hopes Massachusetts can avoid being required to reimburse the federal government and resolve the issue “without any impact to the Commonwealth or to employers.”

Members of the state’s congressional delegation weighed in on Tuesday. In a letter to the US Labor Department, they urged it to “find a solution that will allow Massachusetts to address the problem while minimizing the impact on hardworking people and small businesses in the Commonwealth.”

The Labor Department declined to comment on the letter, though it previously said it’s in discussions with the state.

Unemployment insurance system experts say most states made mistakes implementing federal benefits during the pandemic, but the scope of Massachusetts’ mishap is unusual. Since there’s no real precedent for the Labor Department to follow, it may take some time for its lawyers to determine what’s feasible.

Any amount not waived by the federal government would likely be reimbursed by the UI trust fund or the state with its budget surplus, uncommitted COVID-19 relief dollars, or rainy day fund. A package of these funding sources could be pieced together.

Tapping the UI account is an onerous prospect for employers.

They’re already paying additional fees into the trust fund to cover payments on $2.7 billion of bonds sold by the state last year. Proceeds from the bond sale are being used to repay federal loans the state took out to meet the huge surge in jobless claims during the pandemic, and to provide a cushion for the trust fund.

Members of the Legislature, which approved the sale of up to $7 billion in bonds, are withholding judgment until the Healey administration provides more information.

“We need to learn more about the accounting practices that led to different conclusions at different times and understand more about how the Federal Department of Labor is interested in resolving this problem,” Senator Patricia Jehlen, Senate chair of the Joint Committee on Labor and Workforce Development, said in a statement.

When KPMG identified the smaller misallocation of federal dollars in its 2021 UI trust fund review, its explanation of what happened underscored just how complex the situation was at the height of the pandemic.

From April 2020 to November 2021, banks used by the DUA to distribute unemployment payments returned $318 million, including $127 million in May 2020 alone. Banks send back claim funds when the recipient’s account has been closed, the account number is invalid, or there are suspicions of fraud, which has been a big problem in Massachusetts and other states.

Before the pandemic, the relatively small volume of returns wasn’t hard to process. But that changed when claims surged, especially because banks sometimes made returns without providing information that would have allowed the DUA to determine whether the money should be credited to the trust fund or the federal government.

“Bank returned funds for UI-related programs during this period (both federally and state funded) were not reconciled, not reported on existing forms, had no formal resolution process and, as a result, remained” with the state, KPMG said.

The firm said the DUA used those returned to funds to pay other claims, and it estimated $300 million should be credited to the US Labor Department.

KPMG also detailed instances where mistakes ended up benefiting the state.

The DUA used $316 million of UI trust fund money to pay claims that should have been charged to federal programs. It also took out $362 million more from the trust account than it needed for cover state and federal tax withholdings for benefit recipients.

“The pandemic created some unique and difficult circumstances,” said Evan Horowitz, executive director of the Center for State Policy Analysis at Tufts University and a member of a special legislative commission that studied the state’s UI system. “But it’s still unbelievable that we got our accounts so fouled up that professional auditors can’t spot billions of dollars in misdirected funds.”

Correction: This story has been updated with the complete time frame for Massachusetts’ use of federal money to pay $2.5 billion in state jobless claims.

Larry Edelman can be reached at larry.edelman@globe.com. Follow him on Twitter @GlobeNewsEd.