Cash-rich states create ‘competitive environment’ with flurry of tax cuts

There’s been a wave of state-level tax cuts spurred by budget surpluses, and more breaks may be coming, according to policy experts.

“States have a lot of revenue on hand and they are looking to return it to taxpayers,” said Katherine Loughead, senior policy analyst at the Tax Foundation.

In 2021, 29 states and the District of Columbia enacted “significant” cuts, according to the Tax Policy Center, typically through reduced individual rates or expanded earned income tax credits, a write-off for low- to moderate-income families.

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And this year, at least a dozen states have made cuts or are eyeing reductions, including both temporary and permanent measures, according to the Tax Foundation.  

While there have been some pushes for corporate or property tax relief, income taxes are “the heart of what’s going on,” said Richard Auxier, senior policy associate at the Urban-Brookings Tax Policy Center.

“Overall, most of the tax cut proposals have been relatively modest, and a number have been targeted,” said Brian Sigritz, director of state fiscal studies at the National Association of State Budget Officers.

“The targeted proposals we’re seeing are directed towards helping with the impacts of the pandemic and inflation,” he said.

For example, some of these have included changes to grocery taxes, levies on retirement benefits, earned income credits, small business relief, pausing gas taxes and more.

Annual inflation grew by 7.9% in February, a new 40-year high, according to the U.S. Department of Labor, measuring the costs of food, gas, housing and more.

And “very uncomfortably high” inflation will likely last for another year, Treasury Secretary Janet Yellen told CNBC.

While last year’s tax cuts were primarily done by Republican-led statehouses, rising inflation in 2022 has prompted bipartisan pushes for relief.

“There’s a good mix of tax cuts being proposed by members of both parties,” Loughead said.

For example, Democratic New York Gov. Kathy Hochul called to accelerate a tax cut for middle-class residents, including a property tax rebate program, during her January State of the State address. 

And last week, New Jersey Gov. Phil Murphy, also a Democrat, proposed a property tax relief plan in the form of rebates for 1.8 million homeowners and residents.

The flurry of state tax cuts has been driven by better-than-expected revenues after states sharply reduced forecasts at the beginning of the pandemic, Sigritz explained.

Many states bumped tax deadlines from April to July 2020, pushing a surge of unexpected income into fiscal year 2021, beginning on July 1 in most places. Plus, the American Rescue Plan, signed in March 2021, allocated $195.3 billion in federal support for states. 

Meanwhile, high-income Americans kept working through most of the pandemic, boosting state income taxes, and federal stimulus money bolstered spending in local economies, Auxier said.

“You had this whiplash of ‘the sky is falling’ to strong growth,” he said.

As a result, state revenues collectively grew by 14.5% in fiscal year 2021 compared to 2020, according to a report from the National Association of State Budget Officers.

It was a very surprising result, given the Covid-19 caseloads, local restrictions and business closures, said Tim Speiss, a CPA and partner of EisnerAmper in New York.

While much of the individual relief has made its way through local economies, there is still growth above pre-pandemic levels.

Indeed, 32 states are projecting fiscal year 2022 revenues will be above original forecasts, the National Association of State Budget Officers report shows. 

The slew of tax cuts and proposed relief comes as some higher-tax states shed residents. 

The $10,000 cap on the federal deduction for state and local levies for filers who itemize, known as SALT, has been an ongoing concern for places with above-average income and property taxes.

“They are losing a lot of residents, especially in this era of increased remote work flexibility, where a lot of people can permanently work from wherever they want,” Loughead said.

From April 2020 to July 2021, higher tax areas, such as California, Hawaii, Illinois, New York and the District of Columbia, were the top five to lose residents. 

During the same period, Idaho’s population grew by 3.4%, while Arizona, Delaware, Florida, Montana, Nevada, North Carolina, South Carolina, Texas and Utah all saw 1% growth or more. 

That’s according to a Tax Foundation report analyzing data from the U.S. Census Bureau, U-Haul and United Van Lines.  

“We’re seeing a really competitive environment where states are looking for ways to make a name for themselves,” Loughead said. 

However, some policy experts worry about the long-term effects of permanent tax breaks.

“The troubling thing about rate cuts is they’re very expensive,” said Auxier, explaining how future revenues may not support these moves.

However, some income tax reductions are designed to phase in over a number of years, contingent on future revenue growth to balance budgets, Sigritz said. 

Still, while slashing taxes may be popular in an election year, states still have plenty of time to carefully allocate and spend unused American Rescue Plan funds, Auxier said.