Just Taxes Blog by ITEP

In Drive to Cut Taxes, States Blow an Opportunity to Invest in Underfunded Services

In Drive to Cut Taxes, States Blow an Opportunity to Invest in Underfunded Services

July 7, 2021

Marco Guzman
Marco Guzman
State Policy Analyst

Many states find themselves in a peculiar fiscal situation right now: federal pandemic relief money has been dispersed to states and revenue projections have exceeded expectations set during the pandemic. Meanwhile, more and more workers are returning to jobs as vaccines roll out and typical economic activity resumes. Some states, however, have decided to squander their unexpected fiscal strength on tax cuts.

Although the American Rescue Plan Act of 2021 largely prohibits states from using federal funds to offset reductions in tax revenues caused by cuts, it hasn’t stopped some from using gimmicks like phase-ins or simply attacking the federal restrictions outright to get their way. These states have or are on the cusp of finalizing regressive tax-cut packages that will not only make their tax systems more lopsided but also will blow an opportunity to shore up investments in education, infrastructure, and importantly, boost opportunities for those hit hardest by the economic and health crisis.

In Arizona, the governor approved a tax cut that will conditionally phase in a 2.5 percent flat tax and place a 4.5 percent cap on the top income tax rate paid by wealthy residents. Additionally, another bill likely to be signed into law would give wealthy taxpayers the option to use an alternative filing method, thus allowing them to remove profits from their businesses, trusts, and estates from their taxable income. Not surprisingly, 93 percent of the $1.7 billion tax cuts from the flat tax and 4.5 percent cap would go to those with income in the top 20 percent.

In November 2020, voters passed a ballot measure (52 percent in favor) to implement a 3.5 percent surcharge on high earners to support much-needed funding for education. The 4.5 percent cap on the top rate directly undermines a plurality of voters who wanted the top rate on wealthy taxpayers to be higher. The legislature also tried to greatly expand the state’s school voucher program, but it failed to survive a vote in the House. The attempt was especially egregious because not only do voucher programs undermine public education, but Arizona voters rejected a similar expansion in 2018 by a 65 percent to 35 percent margin.

Republicans in Arizona proved that they aren’t afraid of the political consequences of using their narrow majorities in the House and Senate (a one-vote advantage in both) to push through unpopular policies, and it’s reflective of a broader trend in the state to undermine democracy.

The Ohio governor signed a two-year budget that included a 3 percent across-the-board rate cut, elimination of the state’s top income tax bracket, and an even further reduction of the rate on the new top bracket to 3.99 percent. The income tax cuts follow the same theme as other states mentioned. The top rate cuts will amount to an almost $400 million cut going exclusively to wealthy taxpayers. The approved budget also includes other tax reductions and the expansion of tax breaks that will do little to increase equity.

Ohio has, over the past 16 years, provided significant tax cuts for the richest taxpayers, and at a time when more well-off Ohioans remain relatively unscathed by the economic crisis, a tax cut skewed in their favor is another head-scratching move that will only leave those affected even further behind.

New Hampshire Gov. Chris Sununu signed into law the state’s budget, which includes phasing out the narrow, 5 percent income tax on interest and dividends over five years, in addition to cuts to the business enterprise tax and business profits tax.

According to an analysis, under the phase-out of the interest and dividends tax, taxpayers with taxable income subject to the tax and an average income of $65,000 will see an average tax reduction of just $13, whereas those with an average income of $1.8 million will see an average tax reduction of more than $9,500.

Despite The Granite State’s collection estimates for fiscal year 2021 approaching the same levels as fiscal 2020, combined collections for almost the full year of 2020 were 2 percent lower over the same time in 2019.

The Republican-dominated Assembly in Wisconsin, along with support from four Democrats, approved a budget bill that, among other things, cuts the rate of the second-highest bracket from 6.27 percent to 5.3 percent and reduces property taxes by $650 million—nearly three-fourths of the income tax cut would benefit those earning $100,000 or more.

A separate bill advanced by the Assembly would eliminate the personal property tax, which would primarily benefit businesses.

Lawmakers were emboldened by the state’s recent revenue outlook that put three-year aggregate general fund tax collections roughly $4.4 billion above previous estimates. The two-year budget plan would cut $3.3 billion in taxes while effectively leaving K-12 spending the same and ending an eight-year freeze on tuition for the state university system.

While Democratic Gov. Tony Evers has considerable room to use his veto power—either partial or full—it’s clear that the majorities in the Assembly and Senate care to prioritize tax cuts over ensuring workers affected by the pandemic have the means to get their lives back in order and find better jobs as the economy heats back up.

In North Carolina, a lot more is still up in the air as lawmakers continue to hammer out a budget deal. What’s more certain, however, is that the House and Senate plans—both led by conservative majorities—will include big tax cuts; just how big they will be is the question.

The House initially proposed a budget bill that would have lowered the state’s flat income tax rate from 5.25 percent to 4.99 percent, increased the standard deduction, and expanded the child deduction. Like other states, a mid-June revenue forecast showed that the revised February forecast would add $6.5 billion to the total general fund through fiscal year 2023. The news prompted Senate lawmakers to reach for even deeper cuts like completely phasing out the state corporate income tax and lowering the individual income tax to 3.99 percent.

Democratic Gov. Roy Cooper will have his say when the time comes and could veto the bill if it’s presented in its current form. Whether he can sustain it is another question, as several Democrats already voted for the Senate bill.

North Carolina lawmakers have been on a tax-cutting spree since 2013, which has led to lower levels of revenue in the general fund. If enacted, the Senate plan would find itself more than $7 billion below the historical average as a share of the economy. These cuts could mean real harm to public education in North Carolina, as a judge recently threatened to step in if lawmakers didn’t fund a mandated increase of at least $5.6 billion in new education funding—the governor’s budget funds the first two years, while the Senate plan only funds a fraction of that over the same period.

In the face of an education funding crisis and ever-dwindling general fund revenues, Senate lawmakers still chose tax cuts over services vital to the future growth of the state.

States including Montana, Idaho, Iowa, and Oklahoma passed income tax cuts earlier in the year, and Iowa Gov. Kim Reynolds recently expressed interest in going further and eliminating the income tax, stating, “That’s where (other states are) going. And if you listen to governors, that’s kind of their goal in several states.”

Choosing tax cuts over investments takes a page from an old playbook in which states race to the bottom on individual and corporate tax rates while claiming such policies boost economic growth. Such a shortsighted view ignores the value of states’ greatest assets—their people. Lawmakers should be smart about how they spend their state’s resources, especially since general fund revenue outlooks still remain below pre-pandemic estimates, even despite recent good news about collections.

It’s well known that most state tax systems are regressive, meaning lower-income households overall pay a higher effective tax rate than the highest-income households. After a year in which the gross disparities in our economy became even more apparent, tax cuts for thriving high-income households should not register as a priority.