At the moment, Democrats in Washington appear to be in danger of sleepwalking into a major policy and public relations debacle.
The problem? With tax season underway, millions of Americans who lost their jobs due to the coronavirus crisis could soon find that they unexpectedly owe thousands of dollars to the IRS. Lawmakers could avoid this wave of surprise tax bills by adding a solution to the $ 1.9 trillion coronavirus aid package currently passing through Congress. But so far, efforts to do so appear to be stalled.
A senior Democratic aide told me that as of now, he thought the chances of lawmakers acting were “slim or nil” and described the failure as “political negligence.”
While unemployment benefits have long been considered taxable income, beneficiaries are often unaware of that fact until it is time to file. Under normal circumstances, this is not necessarily a disaster, as people tend to remain unemployed for relatively short periods of time. But the past year has been different. A historic number of households turned to unemployment insurance to survive the pandemic, and some have raised more than $ 10,000 or even $ 20,000 in aid thanks to enhanced benefits that Congress enacted.
Stories are already starting to come in of people hitting submit on their returns, only to be shocked by a tax bill. Take this example, courtesy of a great article by HuffPost reporter and Slate Money co-host Emily Peck:
Julie Evans thought she was getting a refund from the IRS this year, so she got to work on her taxes in early January. Evans, a former administrative assistant, was out of work for all of 2020. To save money, he lives with his adult children in Kent, Washington, and makes ends meet on unemployment benefits. “The idea of about $ 400 [refund] it was tempting, ”he said.
Instead, Evans was shocked: a $ 1,600 tax bill. “I don’t know where I’m going to get the money from,” the 59-year-old told HuffPost.
It is not entirely clear how many households will be affected by this problem, but a recent report from the Century Foundation suggests that the total could be quite large.
By law, states must give applicants the option of withholding some of their unemployment benefits for taxes. Some people turn down the opportunity, either because they need the money right away or simply because they don’t realize the option. But in the bureaucratic fog of the pandemic, some states offered no withholding for federal unemployment benefits created especially for the crisis.
Ultimately, the authors of the Century Foundation report estimate that states only withheld taxes on 40 percent of unemployment payments, meaning that many people could unknowingly owe money.
It doesn’t take a political savant to figure out why this is problematic. From a basic decency standpoint, struggling families don’t need the hardships of a surprise tax bill. From an economic policy-making point of view, it makes no sense to re-tax billions in unemployment benefits and at the same time spend huge amounts of money on a new round of aid. And from a pure policy standpoint, people will obviously get mad if they get hit with a tax bill they can’t pay, or if their new stimulus check is essentially gobbled up by the IRS. Voters will feel angry and misled, and while one after another is showcased on the cable news, it could well undo much of the goodwill the COVID bill could generate for Democrats and the Biden administration.
Once again, some Democrats are trying to avoid this problem before it potentially explodes by including a solution in the $ 1.9 trillion COVID relief bill that is currently making its way through Congress. Senate Majority Leader Dick Durbin and Iowa Rep. Cindy Axne, for example, introduced legislation that would waive taxes of up to $ 10,200 in unemployment benefits. But the House Ways and Means Committee decided not to include the provision. And it’s unclear, at best, whether the idea will make it to the Senate version. “While there is support for tax forgiveness, there are many priorities that members are fighting for,” another Democratic aide told me. “The talks are ongoing.”
Why wouldn’t the Democrats fix this? Part of the answer has to do with arcane rules governing budget reconciliation, the procedure Democrats are using to circumvent obstructionism and pass their COVID bill with just 50 votes in the Senate. Under the process, each committee is assigned a section of legislation, along with a cap on what it is allowed to spend. If the Senate wanted to add a tax correction to UI, the House Finance Committee would have to remove something else from its section of the bill, as the issue would be under its jurisdiction. And finding things to cut is tricky.1
But there could be an obvious place where Democrats could cut back. For now, Democrats plan to give state and local governments $ 350 billion in unrestricted aid to help fix their budgets, plus additional money for schools and transit. As I wrote last week, it’s likely a little more than they need right now, and conveniently, state and local funds go to the Senate Finance Committee section of the bill. Democrats could almost certainly get away with cutting the jackpot by $ 50 billion, which is what Goldman Sachs estimates Americans will owe in taxes on their unemployment benefits. If it turns out that states need more help in the future, Democrats can add it to a bill next year.
If Congress does not act, the Biden administration may intervene. The Century Foundation report argues that unemployment benefits approved to deal with the pandemic should never have been considered taxable to begin with because the IRS code excludes government payments made “in connection with a qualified disaster in order to promote the general welfare. ”Under the Trump administration, the Treasury Department decided unemployment benefits were taxed anyway. But under Secretary Janet Yellen’s new regime, it could potentially reverse course.
So far, the White House has shown no signs that it is willing to do so. Instead, Democrats appear to be wandering toward a completely predictable and completely avoidable identity of their own.
1 No, before you ask, you can’t just save money by cutting from another committee’s section. And no, this is all completely maddening. Add this kind of mindless complexity to the list of reasons why Democrats should just ditch filibuster.