April 20, 2020
State Policy Director
April 20, 2020
Revenue forecasters are grappling with the impossible task of predicting the breadth and depth of state revenue shortfalls caused by the COVID-19 health and economic crisis. Analysts across the country are already reporting that tax collections are falling short. Most states have moved filing deadlines to July 15, which means the surge in revenue often seen in April will be delayed, making revenues even less certain. And this is just the beginning; the full effect of the coronavirus pandemic on state revenue streams remains largely unknown. What we do know is that states are going to be faced with far less revenues to fund vital public services like health, education and infrastructure in the short and long-term.
My colleagues and I have been developing resources to help states position themselves for inevitable deep declines in revenue. One key policy option is to reevaluate recent misguided tax cuts—particularly those that have not yet taken full effect and will add to growing revenue shortfalls in the coming years. States can take immediate action to reverse or delay the damage these tax cuts will ultimately do to their state economies and to the lives of those most affected by the pandemic.
Just When “Ability to Pay” Matters the Most
Arkansas, Tennessee and New York are among the states with scheduled cuts to their personal income taxes. None of these cuts are affordable today, given the rapid pace at which state revenue collections are deteriorating.
Arkansas lawmakers passed legislation in 2019 to reduce the state’s top individual income tax rate over two years. At the time, the top rate was 6.9 percent. It is scheduled to be reduced to 5.9 percent in 2021 and the number of brackets will be reduced to three. These changes chip away at the state’s graduated rate structure and cut taxes for those most able to pay. Corporate income tax rates are also scheduled to be reduced—from 6.5 percent to 6.2 percent in 2021 and down to 5.9 percent in 2022.
Tennessee’s Hall Income Tax on investment income is in the process of being entirely eliminated. Already gradually reduced from 4 percent to 1 percent, the tax is scheduled for repeal in 2021. This would slash resources needed for state and local public services.
In New York, lawmakers implemented tax cuts in 2016 that lowered income tax rates up to 20 percent, creating a projected $4.2 billion in revenue loss by 2025. This year’s enacted budget continues to lower rates for middle-class New Yorkers and benefit the wealthy despite immense revenue needs to the tune of $9 billion to $15 billion in the coming fiscal year.
Additional states with scheduled personal income tax cuts include Iowa, Missouri, Mississippi and West Virginia. And states including Connecticut and Vermont will continue to lose revenue as they phase in larger exemptions to their estate and gift taxes.
Is Your State Budget Having a FIT? This Could be Why.
A range of business tax cuts are scheduled to go into effect in 2021. Indiana, Illinois and Mississippi are among the states faced with revenue losses resulting from ill-advised and catastrophically-timed tax cuts. All three of these states are anticipating revenue losses from cuts to their business privilege or financial institution taxes (FIT).
Indiana’s FIT rate—once 8.5 percent—has already fallen to 5.5 percent and is scheduled to continue dropping under a phasedown to 4.9 percent by 2023. The Hoosier State’s corporate income tax is also on a similar phasedown schedule. Mississippi’s phasedown of its franchise tax began in 2018 and is set to continue through 2028. But that’s not all. In 2016, state lawmakers in Mississippi opted to drag out tax cuts on the bottom personal and corporate income tax rates from 2018 to 2022. Illinois’s tax, historically taxing C corporations doing business in the state, is set to phase out between now and 2023.
Decimated Sales Tax Collections Cannot Withstand “Holidays”
States across the country are coming to terms with an unprecedented drop in sales tax revenues. While it will be months before the economic damage of shuttered businesses, steep declines in income, and housebound consumers comes to light, it’s likely that state and local governments will face historically steep sales tax declines.
And yet, lawmakers in Florida opted to close out their session with a tax package that will cut state and local revenue by nearly $48 million in 2021. The tax cuts are driven by two sales-tax holidays scheduled at the start of the Atlantic hurricane season and at the beginning of the new school year. Temporary sales tax exemptions, while politically popular, are ineffective, poorly targeted alternatives to real sales tax reform.
Don’t Get Dragged Along into Tax Cutting by the Federal Government
The most highly publicized component of the federal government’s Coronavirus Aid, Relief and Economic Security (CARES) Act was a rebate of up to $1,200 per person, but the bill also included an astonishing array of tax breaks for wealthy individuals and large businesses. In particular, a new provision will allow married taxpayers with incomes over $500,000 to use business losses to zero out their personal income taxes. In addition, the bill also raised the business interest deduction cap, changed net operating loss carryforwards and implemented a new $300 charitable deduction. Many states are at risk of seeing these problematic giveaways—and their associated revenue drain—picked up by their own tax codes.
State lawmakers also may wish to use this time as an opportunity to finally debate tax cuts handed down to them by the federal government that, for the most part, were either automatically adopted or adopted with only minimal debate. Repealing giveaways for so-called Opportunity Zone investors and parents sending their children to private K-12 schools should top this list.
The past couple of months have been challenging, and state lawmakers are about to face wrenching decisions. Shortfalls will need to be filled with reserves, new revenue or painful budget cuts. Lawmakers should first look to recent tax cuts that they can no longer afford and take immediate action to reverse or delay those cuts.
When you find yourself in a hole, the first thing you need to do is stop digging.