In the 1978 movie Animal House, an exasperated Dean Wormer threatened members of Delta House that they could have “no more fun of any kind.” Congressional Democrats just issued their own version of that comical mandate in a “tax cut prohibition” on $350 billion in stimulus funds provided to states as part of the newly enacted $1.9 trillion American Rescue Plan. According to 21 state attorneys general, that prohibition effectively bars states in the coming years “from providing tax relief of any kind.”
For states, the tax cut prohibition means accepting that federal stimulus cash is a budgetary one-way street: They can use the money to increase spending but never to cut taxes. As Ohio’s attorney general, who sued the federal government to block the prohibition, recently argued, “The tax mandate in the American Rescue Plan Act uses the federal spending power to compel state tax policy, effectively enacting a tax floor though 2024.” A bipartisan group of 13 other state attorneys general filed a lawsuit last week, arguing that the tax cut prohibition constitutes “one of the most egregious power grabs by the federal government in the history of the United States.”
Consider what the prohibition could mean for unemployment benefits and the taxes that support them. Extraordinary federal pandemic unemployment benefits are well known, including unprecedented $600-per-week supplements (now $300 through September) and a fraud-riddled program covering millions of self-employed workers and others never previously eligible for unemployment benefits. Up to 73 weeks of federal extended benefits today mean unemployment checks can last as long as 99 weeks per person in some states, matching highs seen only during the extended recovery from the Great Recession. Those and other temporary programs have already cost over $500 billion, added almost entirely to federal deficits.
But the pandemic also has exacted an unprecedented toll on state unemployment programs, driven in part by the $600-per-week federal supplements that encouraged their collection. For example, the nonpartisan Congressional Budget Office projected that federal supplements would increase state benefit spending by “about $4 billion” as a result of “more people claiming benefits than would have otherwise.” And that’s just through last July. During the past 12 months, states have spent over $140 billion on state unemployment benefits — five times what they spend in a typical year. Already, 20 states have exhausted their trust funds and now use borrowed federal funds to pay promised benefits.
Unlike federal benefits, whose cost is simply added to the deficit, rising state unemployment spending automatically triggers future state payroll tax hikes on jobs. But the tax cut prohibition blocks states from using the latest stimulus funds to prevent such inevitable tax hikes — even those literally caused by federal benefit expansions, as CBO described. As Sen. Mike Crapo, the lead Republican on the Senate Finance Committee, noted, “If a state decides to use funds to replenish depleted Unemployment Insurance trust funds, so it does not have to raise taxes on employers in the near term during an economic recovery, it can be financially punished by the American Rescue Plan.”
In the context of unemployment taxes, the tax cut prohibition is a reversal of recent federal policy allowing states to use stimulus funds to prevent such tax hikes. After 9/11, Congress gave all states a share of $8 billion in federal unemployment funds, which 30 states used to prevent or reduce future tax hikes. Just last year, about a dozen states tapped the $150 billion coronavirus relief fund created in the bipartisan March 2020 Cares Act to minimize tax hikes on jobs. That bipartisan flexibility has now been replaced by the partisan tax cut prohibition on the latest stimulus funds.
In the end, low-income and middle-income workers will be the biggest losers from Democrats’ insistence that state payroll taxes, which are flat taxes applied on the first dollars of income, must rise. States set their own payroll tax rates and wage bases. Two-thirds of states tax just the first $20,000 in wages or less, and only five states tax wages above $40,000. While employers technically pay the tax, even liberal groups admit that “most economists agree that employees bear the true cost of employer payroll taxes in the form of lower wages.” For workers, and especially those earning modest wages, that means “no tax relief of any kind” will really result in a pay cut. Even Dean Wormer would agree that that’s no fun, either.
Matt Weidinger is the Rowe fellow in poverty studies at the American Enterprise Institute.
