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State Tax Withholding Is Up; $600 Unemployment Benefit May Be Why

Posted on Aug. 5, 2020

Preliminary figures show one exception to the pandemic-related plunge in state revenue collections: Median state withholding receipts are up, which some fiscal experts attribute partly to the now-expired $600 weekly federal supplement to unemployment benefits.

Tax administrators from multiple states described the trend during an informal Multistate Tax Commission roundtable discussion held by teleconference July 27. 

“Revenues have been suppressed, with one odd exception,” said Michael Hale, an attorney with the Kansas Department of Revenue. “We can’t figure out why, but our withholding tax receipts continue to increase every month.” 

More than 54 million individuals have filed initial unemployment claims since March 15. A decline in employment should directly reduce withholding tax revenue, the roundtable participants said.

But Lee Baerlocher, administrator of the Montana DOR’s business and income tax division, said his agency has also seen a large increase in withholding receipts. “We’re real curious to see if this continues throughout the year,” Baerlocher said, adding that he’s worried it will and that Montana is “just going to have to end up refunding it, and really be in a fix.”

It turns out that the evidence for steady or rising state withholding receipts is not merely anecdotal. 

“Withholding taxes have been the relatively good news for states,” said Ronald Alt, an economist and senior manager for research with the Federation of Tax Administrators, in email with Tax Notes.

Alt said that as of August 3, his preliminary data for June shows median state withholding growing by 3.3 percent compared with June 2019. However, the median growth rate was a flat 0 percent for April through June. He added that the FTA is seeing larger variation among the states right now, and that median numbers are moving more than in the past.

“The reason most likely cited is withholding on unemployment compensation,” Alt said. 

The Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136) expanded federal unemployment insurance benefits by an estimated $250 billion. In addition to the $600 federal supplement to state unemployment benefits, the act both extended the period of coverage and provided coverage to more types of unemployed individuals.

Alt said the Paycheck Protection Program component of the CARES Act also has helped keep withholding receipts from falling by providing forgivable loans to businesses that maintain the same number of employees on their payrolls during the pandemic. 

States otherwise are reporting significant declines in tax revenue collections because of the pandemic-related economic downturn and government policy changes implemented in response. The FTA has projected $152 billion in direct state tax revenue losses for April through June, which was the end of the fiscal year for most states; however, after accounting for delayed state tax filing deadlines, many of which were pushed back to July 15, the FTA estimates a net loss of $91 billion.

Lucy Dadayan, senior research associate at the Urban-Brookings Tax Policy Center, has also highlighted withholding receipts as a possible state revenue anomaly. In a June post analyzing preliminary state tax revenue data from April, she called the withholding data the “one bit of good news” in a state revenue story that otherwise “ranges from bad to ugly.” But as Alt had indicated, Dadayan also said that while overall withholding was steady, there was wide variation among individual states, with 17 states reporting April increases in withholding receipts over April 2019 and 21 states reporting declines.

Alt said the large variations might be from delayed unemployment compensation payments. Also, states began reopening in late May and June and employees started going back to work, which Alt said could have led to large jumps in withholding in some states. 

Dadayan is compiling withholding data for the center’s forthcoming State Tax and Economic Review quarterly report. In an email with Tax Notes, Dadayan said that withholding was down in most states in May and up again in most states in June — though she noted that her June data is incomplete.

Dadayan said she believes there are various explanations for steady or rising withholding receipts. 

“My state contacts indicate that the $600-per-week unemployment insurance payments definitely helped,” Dadayan said. “In some cases, taxpayers receiving the extra $600 per week ended up ‘earning’ more from UI than their salaries prior to COVID. In addition, in some states self-employed people would make estimated payments. Some of those self-employed folks are now on UI and therefore paying withholding tax. Also, anecdotally, some big companies made bonus payments, which helped to boost withholding. Sadly, states don’t have a way to know if part of withholding is coming from bonuses or not.”

During the MTC roundtable discussion, participants speculated about whether steady or increasing withholding might be from severance payments or from the $600 unemployment supplement.

Baerlocher said Montana revenue officials don’t believe the unemployment supplement is behind the withholding increases in his state. Dadayan pointed out that Montana is one of six states that do not tax unemployment insurance. The other states are Alabama, California, New Jersey, Pennsylvania, and Virginia. There are an additional nine states without a broad-based income tax, she said.

In theory, some of the increases in withholding during the pandemic could be attributable to temporary telework by employees who live out of state. While several states have agreed to waive nexus for such teleworkers or have issued guidance saying they won’t impose new withholding obligations, many states have remained silent.

But Verenda Smith of the FTA said that no state is enforcing teleworking nexus right now. “Even if they wanted to, they don’t have personnel available to put together a project like that, plus they don’t want to,” she said.

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