A tax on unemployment benefits, a break for affluent Ohioans
A balanced, well-designed tax system makes sure we all do our part to sustain our communities, while caring for people going through hard times. Right now, many Ohioans are going through hard times, but our state tax code hasn’t been designed to help them, especially those who have been laid off during the pandemic.
The hundreds of thousands of Ohioans who were laid off in 2020 will be on the hook for state income tax on unemployment benefits. Unlike with federal income tax on unemployment compensation (UC), Ohio gave claimants no option to have them withheld by the state. With the pandemic and recession far from over, the General Assembly should reduce or eliminate these UC taxes. It could in part use funds that otherwise might be squandered on unproductive tax cuts for the wealthiest Ohioans.
Last year, Ohioans received more than $15 billion in UC benefits, much of that from critical federal programs that boosted the amounts workers received and assisted the self-employed, so-called “gig” workers, and others who don’t ordinarily qualify for benefits. Though the state has not yet provided an estimate to Policy Matters Ohio of how much it expects to collect in income taxes, just a 1% average rate would add up to more than $150 million.
That’s not all. As recent news reports show, thousands of Ohioans who never received benefits could be subjected to federal income taxes because fraudsters including international crime syndicates used stolen identities to collect UC benefits. Ohio Attorney General Dave Yost sent a letter to Ohio’s Congressional delegation asking them to sponsor legislation assuring that victims don’t have to pay income taxes on claims falsely filed in their name.
Taxes on unemployment benefits cut against both of its two purposes: Protecting wage earners from hardship while they are out of work, and boosting the economy by adding to consumer spending power. UC taxes amount to a benefit cut, while also reducing their effect as an economic stabilizer. Economists Alan Blinder and Mark Zandi estimated that a dollar paid in unemployment benefits generates $1.61 in economic activity. Ideally, Congress should eliminate federal income taxes on unemployment compensation altogether. Sen. Richard Durbin of Illinois earlier proposed legislation exempting the first $10,200 of unemployment payments from taxation for 2020.
Look out for working people by bringing more balance to the tax code.
While prospects for ending federal taxation of unemployment benefits may be cloudy, Ohio lawmakers can remedy the problem for Ohio’s income tax. For starters, as long as state income tax is assessed on unemployment benefits, the General Assembly should give unemployed Ohioans the option of having state income tax withheld, as many other states already do. This would eliminate the problem of Ohioans having surprising tax bills. Policymakers should also eliminate the 2020 tax, at least for those of moderate income, and phase the tax out altogether going forward. At a minimum, it should waive all penalties and interest for nonpayment and provide generous repayment terms for two to three years.
One way to pay for this is to make sure that Ohio doesn’t follow along with some of the tax cuts Congress approved last December as part of the latest COVID relief act. That bill authorized another round of Paycheck Protection Program loans to small businesses. These loans will be forgiven so long as employee and other compensation levels are maintained, and they are used for payroll and other eligible expenses. However, in the relief bill passed late in the Trump administration, Congress not only decided to make the forgiven loans tax-free, it also allowed recipients to deduct from their taxes payroll and other expenses they paid with the loans. Congress also made this retroactive to the beginning of the program.
This is a classic double dip for wealthy Ohioans. The Internal Revenue Service specifically prohibited the deductibility of such expenses with the first round of PPP loans, citing existing law and precedent. Now, while hundreds of thousands of Ohioans are paying taxes on the unemployment compensation they received, business owners will avoid paying taxes on their forgiven loans they used to pay workers’ wages, and they’ll get tax deductions. Adam Looney of the Brookings Institution described it this way: “In short, it’s a benefit targeted to a trifecta of inequity: (1) you need to own a business sophisticated enough to get a PPP loan; (2) the more income you have, the more you benefit; (3) your benefit is largest if you’re in the highest tax bracket.” With $800 billion in PPP loans authorized, the deductions could drain the federal government of an enormous amount of revenue.
In Ohio, since we don’t tax corporate income at the state level, it won’t be as costly as in the 44 states that do. However, the tax break also goes to owners of what are called “passthrough businesses,” entities like limited liability companies, S corporations and others whose owners are taxed as the income passes through to them. Ohio already has a lavish tax break for these business owners — known as the LLC Loophole — so they don’t have to pay income tax on the first $250,000 in such business income ($125,000 if married filing separately). The new federal tax break in Ohio will strictly benefit owners with more than that amount of business income. In other words, it’s a giveaway to the most affluent business owners.
Ohio lawmakers can choose to “decouple” from that new federal tax break. The federal tax law is the starting point for our state income tax. Legislators must regularly update Ohio’s law to incorporate changes in federal tax law. State legislators soon will introduce a bill to conform to the federal tax changes – and they should ensure that such expenses paid for with PPP loans aren’t deductible. Policy Matters Ohio has asked the Ohio Department of Taxation for an estimate of the cost of such deductions, but has not yet received one.
At the same time, Ohio should decouple from another unneeded tax break in the federal COVID relief bill: The deduction for business meals and entertainment, colloquially known as the three-martini lunch deduction. Scaled back under the Tax Cuts & Jobs Act of 2017, Congress reinstated it in the December bill. Howard Gleckman of the Tax Policy Center, who called it “a long-standing boondoggle,” described it this way:
“Corporate executive and small business owners routinely used it to write off their personal expense as costs of doing business. Want to take your spouse to a fancy anniversary dinner? Charge it to the business and take a deduction. Want to shoot a round at the country club? Take a client—and claim a deduction. The tax scam has been around so long that martinis had time to be fashionable, become passe, and turn trendy all over again.”
Nor is the deduction likely to turn around dining habits in the middle of a pandemic or be much help to small neighborhood restaurants.
Ohio lawmakers face a twin decision: Do they want to support Ohioans blindsided by a tax on UC benefits they can ill afford? Or will they provide a windfall to some of the most affluent residents in the state by giving them additional tax breaks unavailable to most of us? The public will be watching.