For decades, Democrats have lived in terror of the American public’s (reputed) allergy to taxation. In 2016, the party’s presidential nominee was so afraid of antagonizing her nation’s IRS-averse electorate, she promised not to raise taxes on anyone earning less than $250,000 a year — a pledge that spared all but the top 2 percent of individual earners from the specter of slightly higher tax rates. Four years later, the Democratic standard-bearer decided that Hillary Clinton’s mercy was insufficiently broad, and vowed to exempt “middle class” Americans at the bottom of the top 1 percent from any and all tax hikes (despite the fact that Donald Trump had lowered rates in the interim). Meanwhile, like pizza chefs condemned to cook pies exclusively for lactose-intolerant sufferers of celiac disease, Democratic policy wonks have been forced to concoct sorry substitutes for social democratic programs, lest their recipes send the voting public into the political equivalent of anaphylactic shock.
And yet, Democrats are about to let the IRS unleash large, surprise tax bills on millions of Americans who lost their jobs during the COVID-19 pandemic.
The cause of this development is simple, and its adverse political implications long foreseen. Unemployment benefits qualify as taxable income, a reality that often takes recipients by surprise come tax season. But in ordinary years, the number of Americans facing large, unanticipated IRS bills as a result of receiving unemployment benefits is sharply limited by three factors: (1) The number of Americans who typically collect unemployment benefits for an extensive period of time tends to be small, (2) state unemployment insurance offices tend to withhold a percentage of UI benefits for tax purposes, and (3) (lamentably) America’s unemployment benefits tend to be quite low, at least by OECD standards.
But 2020 was no ordinary year. Roughly 40 million Americans qualified for unemployment benefits at some point last year, with nearly 5 million remaining jobless long enough to see their benefits expire. Thanks to the CARES Act’s federal unemployment benefits, for much of 2020 America’s wage-replacement rates were among the most generous in the world, with the nation’s jobless collectively taking home $580 billion in benefits by year’s end. Finally, as state UI offices were inundated with jobless claims, many neglected to withhold any taxes from the federal benefits they dispersed. According to an analysis from the Century Foundation, only “40 percent of UI payments in 2020 had taxes withheld,” while the average UI recipient collected approximately $14,000 in UI income. Taken together, these figures suggest that millions of households are going to face a significant, surprise tax bill, absent congressional action.
Senate Budget Committee Chairman Bernie Sanders has long called for tax forgiveness on UI benefits accrued during the pandemic, and Senate Majority Whip Dick Durbin and Iowa representative Cindy Axne have introduced legislation that forgives taxes on the vast majority of UI income. For whatever reason, however, Democrats failed to find a place for the provision in their $1.9 trillion COVID-relief package. Some lawmakers are currently pushing to add tax forgiveness to the bill. But the legislative strategy that Democrats are using to get the relief bill through the Senate makes the task of adding new provisions more daunting.
The COVID-relief package is a “budget reconciliation” bill, a category of legislation that is immune from the Senate filibuster. In order to pass such a bill, however, Congress must first pass a budget resolution that places a ceiling on the legislation’s total cost. That ceiling is now fixed at $1.9 trillion, which means that adding tax forgiveness to the bill would require subtracting some other funding priority from it.
Fortunately, Democrats have some low-pain options for swapping in the tax forgiveness funds. As Slate’s Jordan Weissmann notes:
At the moment, Democrats are planning to give state and local governments $350 billion in unrestricted aid to help patch up their budgets, on top of additional money for schools and transit. As I wrote last week, that’s likely a bit more than they need at this point, and conveniently, the state and local funding is assigned to the Senate Finance Committee section of the bill. Democrats could almost certainly get away with shrinking the pot by $50 billion, which is how much Goldman Sachs estimates Americans will owe in taxes on their jobless benefits. If it turns out states do need more help down the line, Democrats can add it to a bill next year.
Notably, even if one disagrees with Weismann’s assessment of how much fiscal aid states require, Democrats could still append the difference to their upcoming, second reconciliation bill. States and municipalities won’t blow through $300 billion in a matter of weeks. There is no huge time crunch on getting them that last $50 billion. But Democrats have no time to spare if they want to avert an epidemic of surprise tax bills; Americans are already receiving them. As Emily Peck of Huff Post writes:
Julie Evans thought she’d get a refund from the IRS this year, so she got to work on her taxes first thing in January. A former administrative assistant, Evans was out of work for all of 2020. To save money, she is living with her adult children in Kent, Washington, and scraping by on unemployment benefits. “The idea of $400 or so [refund] was enticing,” she said.
Instead, Evans got a shock: a $1,600 tax bill. “I don’t know where I’m going to come up with the money,” the 59-year-old told HuffPost.
If Congress doesn’t act, the Treasury Department might be able to unilaterally forgive a portion of the taxes that UI recipients owe, according to the Century Foundation. But such relief would be partial and convoluted to administer.
The Democratic Party’s fear of broad-based tax increases — and resulting disinclination to establish new, universal social programs — is frustrating but understandable. Raising taxes on the middle class is a genuinely politically risky endeavor, given the American public’s (understandable) lack of faith in their government. But if the party is going to prioritize low taxes for the upper-middle class over social insurance for all, the least it can do is to not let the IRS hit the recently jobless with multi-thousand-dollar tax bills (and/or hoover up their $1,400 checks) because it couldn’t find $50 billion for targeted tax forgiveness in a $1.9 trillion bill.