Time machine is NOT excluding downloads I have OSx Catalina. I have several folders and disks excluded from TimeMachine.
TEST:

I use Terminal to navigate to Downloads folder.
I touch junk.txt
I Enter Time Machine and navigate to Downloads.
From there the Now frame shows junk.txt.
If I go back in time, junk.txt disappears, yet all the other files still show.
I expect that going back in time from Now frame, all files would disappear in all but Now frame.

Is this a known issue?
I understand may be a &quot;System Folder&quot; but I could not find any documentation that states that this folder can not be excluded as well as it shows up in list of exclusions.
However, as comment below, if I peruse through Volume using Finder, I do not see Downloads folder at all.
Odd behavior. Partition is encrypted. Even without decrypting partition, e.g. Disk utiltiy lists partition as Not mounted, I am able to open Time Machine and go back in time as well as restore a file from Downloads. How's that!
Great details - since you are in the command line already we should be able to get some very critical details sorted and help you understand how the system works, validate it’s configured and perhaps let you solve this.
The three big commands are tmutil isexcluded and tmutil startbackup --block and tmutil compare
You should be able to check at any time if the file you have is excluded - so start with that and make sure you are agreeing with whether it’s included and excluded as you move it from folder to folder - from ones that are and are not excluded.
Then once you see it included, run the compare against the last backup - see that it’s flagged as different, then force a backup and re-check the compare.

Once you’re sure the backups are happening in the command line (or not) then we can look if you need to diagnose Time Machine itself or if the GUI may be lagging or broken or it’s just a misconfiguration  that can be sorted.