State Legislatures Take Up Tax Reform in 2022

Lawmakers are considering a measure to exempt groceries from the sales tax base, an idea also under consideration in Kansas and Virginia. Unfortunately, this narrows the sales tax base while doing relatively little to make the sales tax more progressive, given that SNAP and WIC purchases are already exempt. In Alabama, this effort takes the form both of a legislative carveout (HB 174) and a constitutional amendment (HB 173) which would make the exclusion more permanent. The constitutional amendment would also cap the state’s unusual federal deduction at $4,000; we have written previously about how Alabama should scrap this distortionary policy altogether.

Republican lawmakers in Arizona have contemplated, but not yet unveiled, strategies to avert a pending ballot measure challenging the state’s transition to a flat tax. For now, however, there’s a serious legislative effort (HB 2440) to cut the corporate income tax rate from 5.5 to 4.9 percent, and a presumably much-less-viable proposal to adopt the nation’s first net worth tax (SB 1107), which would impose a rate of 1 percent on all net worth (excluding home value) above $50,000.

With a $31 billion budget surplus, California has plenty of room to maneuver, and Gov. Gavin Newsom (D) has responded by proposing a one-year suspension of the automatic gas tax adjustment and the restoration of net operating loss (NOL) provisions a year early, after they had initially been suspended for three years. (California is the only state which doesn’t currently offer NOLs.) Separately, some lawmakers are championing a $163 billion tax increase package—a doubling of pre-pandemic tax collections—to establish single-payer health care in the Golden State, a package we analyzed here.

In Colorado, Ballot Initiative 31 would build on a 2021 rate reduction, further trimming Colorado’s income tax rates from 4.55 to 4.4 percent. Separately, HB 1021 would accomplish the same rate by legislation, obviating the need for the ballot measure. Given substantial revenue growth and Gov. Jared Polis (D)’s support for tax relief, a rate reduction seems quite possible. More controversial would be HB 1125, which would grant permanence to the one-year rate reductions that can be triggered by the state’s Taxpayers’ Bill of Rights (TABOR). Another bill, HB 1062, would exempt prepared foods from the sales tax, which would be without precedent elsewhere—though Kansas is considering the same thing.

In Connecticut, Gov. Ned Lamont (D) has signaled support for enhancing the state’s property tax credit, while Republicans are calling for part of the state’s surplus to be returned to taxpayers in the form of a reduction of the general sales tax rate from 6.35 to 5.99 percent, and the temporary elimination of a 1 percent surcharge on prepared foods (including restaurant meals).

In Florida, Gov. Ron DeSantis (R) has proposed temporarily suspending the gas tax entirely, using a combination of state revenue growth and ARPA fiscal recovery funds, setting up a challenge over the Tax Mandate, which does not allow those funds to be used for tax cuts.

Hawaii is the rare state mostly exploring tax increases, including a new corporate income tax rate of 9.6 percent (HB 1505 and SB 2242); a new top individual income tax rate of 13 percent above $500,000, which would be the nation’s second-highest; and eliminating the state’s preferential rate on capital gains income. At a time when most other states are cutting taxes to enhance their overall competitive standing, this could put Hawaii at a substantial disadvantage. Hawaii has a $1 billion budget surplus, and the one tax relief measure currently under consideration is Gov. David Ige (D)’s proposal of $100 refunds for each taxpayer and dependent.

Governor Brad Little (R) has promised $1.5 billion in additional tax relief over the next five years, and there is legislation (HB 436) to begin this effort with a reduction of individual and corporate income tax top rates from 6.5 to 6 percent, coupled with a one-time tax rebate worth $350 million. A separate effort (HB 448), not part of the governor’s proposals, would exempt groceries from the sales tax base, a far less efficient way to return revenue growth to taxpayers.

Although major tax proposals have yet to be unveiled, Gov. J.B. Pritzker (D) is expected to outline plans for a one-year suspension of the 1 percent sales tax on groceries, freezing the gas tax rate for a year, and providing a property tax rebate of up to $300. Beyond that, major tax changes seem unlikely in Illinois this year, but one bill (HB 4330) would increase the state’s estate tax exemption to match the federal amount.

The House has already approved, and the Senate will soon consider, a proposal (HB 1022) to phase down Indiana’s 3.23 percent flat income tax rate to 3 percent by 2026. A competing bill (SB 372) would bring the individual income tax rate to 1.73 percent and phase out the corporate income tax entirely, but create a new gross receipts tax on social media advertising. How this plan would balance is not immediately obvious, and the proposal not only confronts the legal and economic questions raised by Maryland’s digital advertising tax, but also specifically targets a single industry with dubious justification. Meanwhile, Gov. Eric Holcomb (R) has proposed eliminating the 30 percent business tangible property tax floor on new manufacturing equipment, further enhancing the state’s treatment of tangible property.

Gov. Kim Reynolds (R) plans to accelerate and build on a previous round of reform by phasing down the income tax to a flat rate of 4 percent by 2026 and reducing the corporate income tax rate to 5.5 percent. Her plan would also exclude retirement income from taxation. A Senate plan calls for a flat 3.6 percent individual income tax by 2026, exempting retirement income, reducing the top corporate income tax rate to 7.8 percent, and raising the sales tax rate to 7 percent, with some of the revenue allocated to local governments in lieu of the current local option sales tax.

In Kansas, legislators adopted substantial reforms with a veto override last year. This year, Gov. Laura Kelly (D) has proposed using continued revenue growth to eliminate groceries from the sales tax and provide a one-time cash rebate, proposals some Republican lawmakers have given a cold reception. The legislature is also considering proposals to exempt Social Security income from taxation, reduce senior citizens’ property taxes, and cap the growth of government.

Gov. Larry Hogan (R) is seeking to end his time in office delivering on his long-standing proposal to exempt retirement income from the income tax, and he has proposed expanding the state’s earned income tax credit.

The Bay State is not short on proposals to raise taxes. Even though the economic harms of gross receipts taxes are widely understood, lawmakers have proposed a 0.25 percent gross receipts tax on large businesses (H. 2855), in addition to several competing proposals to tax digital advertising like Maryland now does. Another bill (S. 1839) would increase the corporate income tax rate to 9.5 percent, and to 10.5 percent for financial businesses. In one break with efforts to reclaim the old Taxachusetts moniker, Gov. Charlie Baker (R) has proposed the elimination of the state’s 12 percent rate on short-term capital gains. Massachusetts is the only state to tax capital gains income at a higher rate than ordinary income.

Senate Republicans in Michigan are advancing a measure (SB 768) to cut both individual and corporate income tax rates to 3.9 percent, about a $1.6 billion recurring tax cut, in addition to one-time tax refunds paid for out of the current surplus. The bill received a favorable report in the Senate Finance Committee. In the House, another Republican bill, HB 5688, would trim the rate one time, from 4.25 to 1.15 percent. Gov. Gretchen Whitmer (D) has indicated that she prefers targeted tax relief for seniors and low-income taxpayers by exempting retirement income from the income tax and raising the Earned Income Tax Credit.

Under HB 531, which cleared the House on an overwhelming bipartisan vote, Mississippi would ultimately repeal its individual income tax, raise its sales tax rate from 7 to 8.5 percent, and exempt groceries from the sales tax base. As designed, it would phase out the individual income tax through exemptions rather than rate reductions and using revenue triggers which may yield budget cuts in real terms by inadequately accounting for inflation, as we noted here. An improved design could still yield substantial income tax rate reductions without cutting into the state budget.

Gov. Mike Parsons (R) wants to trim the top individual income tax rate from 5.4 to 5.3 percent this year. Several Republican lawmakers would go substantially further. Missouri has adopted and then accelerated revenue triggers on multiple occasions, and SB 739 would revise current triggers to permit a 0.1 percentage point reduction for each $145 million over baseline collections, with an upward adjustment of the baseline after each cut, to allow government to retain half of future revenue growth. The pace of current collections is sufficient to lower the top rate to a projected 4.6 percent in 2023. Separately, SB 701 would repeal the corporate income tax, which brings in about $560 million a year. The state is currently showing a large surplus, with forecasts of robust future revenue growth as well.

A Democratic lawmaker has introduced legislation (LB 1264) consolidating and lowering income tax rates, with a top rate of 4.99 percent by 2028, and eliminating the inheritance tax after 2023, while expanding the sales tax to select services. It is one of the more comprehensive tax reform plans introduced thus far this year. A separate, much more modest bill moving its way through the legislature (LB 310) increases exemptions while reducing rates under the inheritance tax. In his State of the State Address, Gov. Pete Rickets (R) called for a range of tax relief efforts, including reducing the top individual income tax rate by 1 percentage point over five years.

New Mexico Gov. Michelle Lujan Grisham (D) has made a reduction in the state’s very broad-based, hybrid sales tax (which the state calls a gross receipts tax) a priority, and legislation (SB 5) affecting that rate reduction, from 5.125 percent to 4.875 percent, has been introduced but not yet heard in committee.

Only New York and the District of Columbia raised income taxes last year, but now, while retaining the new higher top marginal rates, Gov. Kathy Hochul (D) wants to accelerate planned income tax cuts for middle-income taxpayers. These lower rates were intended to phase in by 2025, but Hochul suggests using the state’s large surpluses to institute the reduced rates by 2023, and to provide $2.2 billion in homeowner property tax rebate credits for low-and middle-income taxpayers and senior citizens. The new rate on income between $80,650 and $215,400 (after inflation adjustment) would be 5.5 percent, down from the 2021 rate of 6.33 percent. Before the phase-in, this income was taxed at 6.85 percent. In fact, not terribly long ago, 6.85 percent was New York’s highest rate, and if five temporary tax increases and extensions are ever allowed to expire (currently scheduled for 2027), it would be again. Even before the latest rate increase or the reduction for middle-income earners, almost 90 percent of individual income tax liability fell on the top 25 percent of earners, and about 63 percent on the 5 percent of filers with more than $200,000 in income, which the state’s budget director has cautioned is a cause of outmigration.

Some lawmakers are exploring the repeal of Ohio’s gross receipts tax, the Commercial Activity Tax (CAT). Under the proposal (HB 234), the tax would be phased out over five years, with full repeal in 2026. Ohio’s CAT was implemented in 2005 as a replacement for the state’s corporate income tax, a capital stock tax, and the tax on business tangible property. Public finance scholars and many Ohio lawmakers agree that gross receipts taxes are poor tax policy, but in Ohio, this recognition tends to be moderated by the recollection that its adoption represented a substantial net tax cut in the elimination of those three other taxes. Ultimately, however, repealing the CAT or replacing it with a different business tax could dramatically enhance Ohio’s tax competitiveness.

The Pennsylvania House of Representatives has approved legislation (HB 333), now pending in the Senate, to increase small business expensing under Section 179 from $25,000 to the federal level of $1 million (inflation-adjusted). Pennsylvania’s current treatment is tied for the stingiest nationwide, whereas the $1 million level would represent current national best practice. At the same time, legislation has been introduced to raise the Commonwealth’s state sales tax rate from 6.0 to 6.5 percent to fund an additional property tax rebate for seniors (HB 2203).

Local governments may soon have discretion over whether to adopt tangible personal property exemptions of their choosing under a proposal in the budget of Gov. Daniel McKee (D). The governor also proposes a slight haircut to the $400 minimum tax (to $375) for businesses, but the flexibility for local governments to exempt some portion of tangible personal property from taxation is more significant and is in line with recommendations the Tax Foundation has made in other states as a way to reduce this tax on business investment.

Gov. Henry McMaster (R) wants to implement a 1 percent across-the-board income tax rate cut over five years, beginning with a $177 million reduction. A more aggressive approach, found in S.924, would adopt a single-rate 3.5 percent income tax and exempt the income of pass-through businesses. South Carolina already offers pass-throughs a preferential rate, but no state currently exempts them entirely while still taxing other forms of individual income, though Kansas did this briefly as part of their quickly reversed, budget-busting tax experiment. Whatever cuts South Carolina makes, zero-rating pass-through business income provides strong incentives for individuals to recharacterize their activity to claim the exemption. Separately, a Democratic legislator has proposed raising the top rate to 9 percent to fund non-means tested annual $400-per-person checks (H.4856).

Democratic Sen. Heidi Campbell (D) has legislation (S.1898) to reduce the sales tax rate by 1 percentage point. With the full repeal of the Hall Income Tax on interest and dividend income, Tennessee is now one of eight states not to tax any personal income, though the state has a high sales tax and several layers of taxes on business income, including the income of pass-through businesses normally subject to individual income taxes.

Lawmakers are advancing legislation (SB 59) to trim the individual income tax rate from 4.95 to 4.85 percent. Legislation that would have cut the rate to 4.5 percent has not advanced. Separately, SB 62 would reduce the corporate income tax rate from 4.95 to 4.6 percent, and Gov. Spencer Cox (R) has proposed a grocery tax credit on the income tax, designed to offset groceries being subject to a 3 percent preferential sales tax rate.

Gov. Phil Scott (R) unveiled a proposal to increase the Earned Income Tax Credit to 45 percent of the federal credit, raise the Social Security exemption from $45,000 to $75,000, and increase the child and dependent care credit.

In the only state where the governor’s office changed hands this year, Gov. Glenn Youngkin (R) has proposed tax relief in a variety of forms, including doubling the standard deduction, eliminating the state’s preferential-rate sales tax on groceries, temporarily suspending a gas tax increase, and providing one-time tax rebates with the Commonwealth’s current surplus. Raising the standard deduction—building on a recent increase from an initially very low level—is overdue. However, eliminating the sales tax on groceries involves making localities whole, which adds not only cost but complexity to this base-narrowing provision.

The most notable legislation in Washington is a Democratic bill (SB 5932) to reduce the sales tax rate from 6.5 to 5.5 percent, which runs counter to the many bills—this year and in prior years—to raise a range of taxes. Other bills introduced this year would allow local income taxes, impose high-rate gross receipts taxes on the sale of personal data, and increase the rate of the new capital gains income tax for the highest earners.

A Democratic lawmaker has introduced legislation (SB 457) to reduce the sales tax rate from 6 to 4.75 percent subject to revenue availability, based on reserve funds thresholds. This could amount to significant tax relief, though it also runs counter to prior proposals by the Republican majority to raise the sales tax rate to offset income tax rate reductions.