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TEMPORARY SUSPENSION OF TAXATION OF UNEMPLOYMENT BENEFITS

Key Points

 

·        Exempts from income taxation up to $2,400 of unemployment compensation received by each beneficiary during 2009.

·        Tax savings depend on tax bracket so low-income unemployed get smallest benefit.Maximum benefit would be $240 for households in 10 percent tax bracket and $840 for those in 35 percent top tax bracket. Those with income too low to have tax liability before credits would get no benefit.

·        The stimulus effect would not occur quickly because most taxpayers would not benefit until they file their 2009 tax returns in 2010.

·        Spending the same amount of money to increase unemployment benefits would have faster and greater stimulus effect by delivering funds more quickly and targeting more income to low-income households that would more likely spend additional money.

·        JCT estimates that the proposal would cost $4.7 billion over 10 years.

Current Law

 

Unemployment compensation is currently fully subject to federal income taxation.

Stimulus Proposal

The proposal would exempt from federal income taxation up to $2,400 of unemployment compensation received by each unemployed worker. Most taxpayers would benefit from that exclusion when they file their 2009 federal tax returns in early 2010.

Discussion

Because the exclusion would reduce taxable income, its value to taxpayers would depend on their tax bracket. Those facing a 10 percent tax rate would save up to $240 in federal taxes while those in the 35 percent top tax bracket would see their tax bills drop by up to $840. Households with no taxable income—including unemployment compensation and after subtracting exemptions and deductions—would not benefit at all from the provision.

Unemployed workers receive unemployment compensation without any withholding for potential income tax liability. As a result, any benefit from not taxing some or all of the compensation typically would come only when they file tax returns and either get a larger refund or have to pay less additional tax. Taxpayers who have other income subject to withholding could reduce the amount withheld but few people would likely do so. Thus, most of the additional money that unemployed workers would get from this provision would not come until they file their 2009 tax returns a year or more from now. That delay would postpone any stimulus effect of the tax change.

Unemployed workers experience a marked drop in income, even counting unemployment compensation. Most states limit unemployment benefits to about half of previous earnings, subject to state maximums. In December 2008, nearly 19 million people received unemployment compensation averaging just under $300. Because their income has fallen, recipients would likely spend much of their benefits and would also likely spend any tax savings. This provision is thus well targeted and would be effective as stimulus if it were timelier.

A more effective stimulus would come from using the same amount of money to increase unemployment compensation. That would make funds available immediately. It would also redistribute benefits from high-income recipients to those with lower income by separating the value of the provision from recipients’ tax rates. Because low-income households are more likely to spend additional income than high-income households, that change would also increase the amount of stimulus.

Grade: B-

The provision is well targeted on households whose income has fallen because of unemployment but the fact that benefits are proportional to tax rates means that larger gains would go to high-income taxpayers, thus weakening any stimulus effect. Because most households would see no income change until they file their tax returns in 2010, the provision’s impact would be delayed. Using the same amount of money to increase unemployment benefits for all recipients would improve both the targeting and timeliness of the provision and earn an “A.”

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