When "Optimize Mac Storage" is DISABLED, then all files in iCloud Drive are also stored on your Mac. In that case, the locally synced copies of the files are actually stored in the following path, which is included in Time Machine backups:
~/Library/Mobile Documents/com~apple~CloudDocs
One caveat to also understand is when iCloud "Desktop & Documents" is enabled, Finder simply hides those from you when viewing your home folder and instead shows them under iCloud Drive. The actual folders have not moved however and are still in the original paths, and therefore still included in Time Machine backups:
~/Desktop
~/Documents
You can check these paths for yourself by using either Terminal, or, by using the following Finder feature. In Finder > View menu > Show path bar. Then, select iCloud Drive and in the path bar at the button, right-click and choose "copy ... as a pathname". Paste the clipboard into a text document and you will be assured as to the actual paths being used by iCloud Drive, Desktop, or Documents, depending on which iCloud Drive features are enabled.