The unemployment benefits system was built on a combination of wishful thinking, generosity, and skimpy funding during good times. Today, it's likely impeding job growth.

By Nina Easton, senior editor-at-large

FORTUNE -- Hemingway Apparel, located in a rural former cotton town a hundred miles east of South Carolina's capitol, should be the kind of small business that government nurtures. In a county where the unemployment rate hovers near 12%, the factory employs low-skilled workers who don't have a lot of options.

Hemingway barely survived the drift of apparel production overseas. Today, company owner Jack L. Marsh benefits from the "Made in America" determination of top customer Angela Newnam.  The Harvard Business School grad and former McKinsey consultant also happens to be a daughter of the Carolina textile mills who is putting her company, Knockout Panties, behind her stubborn belief in American manufacturing.

The Marsh-Newnam partnership has all the makings of a grassroots business story that -- stitched with thousands of others -- could aid an American jobs revival. Except for one thing: Marsh isn't hiring. He's being killed by unemployment taxes that are on their way to quadrupling since 2009. When new business comes calling, Marsh says, "I have to ask myself if there's another way to meet production needs without adding employees.'' He would rather pay overtime than shell out a per-worker tax of $900 (up from $270 three years ago) that is slated to rise to about $1,100 in 2014.

While Fortune 500 executives regularly complain that "uncertainty" over taxes and other government policies is holding back hiring, small businesses face a grim certainty -- their costs of doing business are definitely going up. Now that the Supreme Court has upheld the Affordable Care Act, companies with more than 50 employees will be required to offer health insurance or pay a fine, potentially discouraging expansion.

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After four years with a U.S. jobless rate hovering above 8%, states have run out of money. They've borrowed from the federal government, and are now raising taxes on business. So unemployment taxes, which is essentially an insurance system meant to provide a temporary cushion for laid-off workers, is actually impeding the creation of jobs that would help them get back into the workforce.

Between 2008 and 2011, $174 billion in unemployment taxes was collected while $450 billion was paid out in benefits, a gap of $276 billion. Thirty-four states blew through their unemployment insurance trust funds and borrowed from Washington -- and 22 of those still owe the feds a total of more than $30 billion, according to the Tax Foundation. The foundation's study concluded that some states will not fully repay those loans for years. More