States cutting taxes amid budget crisis

Tax cuts have been made in nearly every state over the last few years, but as the economy began to return to normal, budget deficits began to emerge.

“The last few years have been about tax cuts,” said Richard Auxier, chief policy associate at the Urban-Brookings Tax Policy Center. “From 2021 to 2023, 48 of the 50 states have cut taxes.”

“This is the way to bring tax increases back to the table as part of state fiscal negotiations.” The comments came during a webinar hosted by the Brookings Institution on Tuesday.

The combination of federal stimulus dollars, the resulting economic boom, and increased tax revenues flowing to the states translated into fat budget surpluses and, eventually, tax cuts. The cuts came in the form of one-time reductions, property tax caps, expanded exemptions, and constitutionally mandated refunds to taxpayers.

Some state budget watchers are concerned about the resulting funding shortfalls and the amount of political capital needed to raise taxes to close the gap.

“At that moment, your future or your policy goals are not at stake,” Auxier said. “Can we get back on our feet?”

Nebraska Gov. Jim Pillen earlier this year promised taxpayers a 50% cut in property taxes, which would have resulted in a $1.85 billion deficit, according to the Center on Budget and Policy Priorities.

The governor’s deal with lawmakers in August called for a 20% reduction, along with budget cuts, cash transfers, increased wages and a dip into the state reserve fund to cover the deficit.

Arizona faces a $1.6 billion deficit by fiscal 2025, according to the CBPP. Kentucky abandoned a plan to eliminate its state income tax in May.

“One of the distinguishing factors of our study is that states and local governments, unlike the federal government, have to balance their budgets,” said Wesley Tharpe, senior advisor for state tax policy at CBPP. “State politicians have to make these really tough choices.”

The Biden administration has proposed a 25% income tax on individuals earning more than $100 million, but noted that their income often doesn’t show up as wages. The idea of ​​taxing the rich has also been well-received in many states, including Massachusetts.

“Voters in 2022 approved a new tax on incomes over $1 million that has the potential to generate at least $2 billion annually and is expected to be used specifically for public education and transportation,” Tharpe said.

Tharpe also mentioned a Washington state excise tax that goes into effect in 2021 on the sale of stocks and investments, including bonds, paid for by the state’s richest 0.02% of taxpayers. The “capital gains tax” diverts at least half a billion dollars of revenue annually into state coffers.

Repealing that tax is on the ballot in November of this year, and Democratic Governor Jay Inslee has voiced his support for keeping the tax in place.

The results of the upcoming elections will also determine the fate of the federal Tax Cuts and Jobs Act, which could have repercussions for state revenue streams.

The future of caps on state and local tax deductions could play a role, but some tax experts believe the issue has gotten too much attention.

“I think the SALT border is the most exaggerated, most debated issue in the world,” Auxier said.

“There’s a lot we need to put into context all the trends that will impact taxpayers and governments.”

Tax manipulation, budget wars and the ongoing threat of a government shutdown that could halt the flow of federal funds to states all affect state credit scores. So far, no alarm bells are ringing.

“States have returned to more typical budgeting practices with modest revenue growth expectations in fiscal 2025 and the need to address some spending pressures,” said Karen Krop, senior director at Fitch Ratings.

“As a result, some states are tapping into accumulated balances for one-time expenses, while others are tapping into rainy day funds to help balance their budgets while still maintaining strong operating reserves.”