Individual Income Tax Insights: State Tax Reform in The Age of The Partisan Divide

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Ideological strife has gripped state legislatures across the country as revenue shortfalls and budget deficits grow. Some argue that tax reform is needed to improve states’ fiscal health, however, the “how” of tax reform remains elusive. Negotiations have fallen apart mainly on party lines: Republicans focus on tax reform centered on economic growth intended to benefit everyone; Democrats focus on lifting people out of poverty as the most inclusive path to growth. Republicans accuse Democrats of being anti-growth and job-killers; Democrats counter that Republican pro-growth policies make the poor poorer and the rich richer. 

Lost in this back and forth is the fiscal reality many states are facing. Total state revenue has been falling for years, in states as varied as Oklahoma, Connecticut, and Kansas. A different, although related, issue faces many more states: budget shortfalls. Alaska, Pennsylvania, and Illinois are each facing billion-dollar-plus budget deficits, highlighting the need for real tax reform to protect essential state services and compete in the twenty-first century. This blog post highlights the progress that legislatures have made towards addressing this issue, and the ways in which people from both sides of the aisle are coming together or, most often, widening the partisan divide. 

Return of the Income Tax?

Alaska, after 37 years, is considering reinstating its income tax through H.B. 115. The bill narrowly passed the House but was met with opposition in the Senate and voted down. The bill would have created a progressive tax system with six brackets, ranging from 0 percent up to 7 percent for those making over $250,000 per year, and was endorsed by Alaskan Governor Bill Walker (I). Alaska has several other options to raise revenue or cut spending, including introducing a sales tax, increasing oil taxes, and limiting oil credits. A bill to reduce the Permanent Dividend Fund payout, S.B. 26, passed both the Senate and the House before being partially vetoed by Gov. Walker, reducing the payout by less than what was originally proposed. Gov. Walker has called a special session to address Alaska’s fiscal issues and get a budget worked out. 

Budget Proposals Far, Far Apart

Meanwhile, in Pennsylvania, the GOP-lead House authored a budget bill that contains spending levels approximately $800 million below Governor Tom Wolf’s (D) budget proposal. The Governor’s plan includes revenue from a tax on the shale industry as well as an increase to the state minimum wage, expected to result in a windfall for state coffers. The GOP budget introduced no new taxes, expanding state gambling and reforming liquor sales while trimming state services to close the state’s estimated $1 billion dollar revenue shortfall. In a state facing not just budget shortfalls but also revenue falling short of projections, some argue the need for tax reform is greater than ever. 

The Budget Crisis Awakens

Last but not least comes Illinois, which faces a $5 billion backlog of payments needed for fiscal year 2015 and a 2016 budget that was passed with a $4 billion shortfall. The Senate passed S.B. 9, expected to raise taxes by $5.4 billion through an increase in personal and corporate income tax rates, expanded sales taxes, and real estate tax increases. Although appearing to be a promising sign, the move indicates a failure of the so-called “Grand Bargain,” a mixture of spending reform and tax hike legislation designed to solve the impasse between the Democrat-controlled legislature and Governor Bruce Rauner, a Republican.  

Can’t We all Just get Along?

Issues relating to revenue shortfalls and budget deficits can seems esoteric, but have real consequences on a state ability to compete not only domestically but globally. Illinois’ credit rating was recently downgraded to BBB by Fitch, a credit rating agency, just two positions above “junk” status. This action in turn raises borrowing costs for Illinois, forcing the state to rely more and more on raising revenue, which tends to make Illinois a less competitive state. Pennsylvania, Alaska, and several other states face a similar fate if their short and long term liabilities are not dealt with prudently. 

Continue the discussion on the BBNA State Tax Group on LinkedIn: Should states expand their revenue base or increase tax rates to make up lost revenue? 

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By Kevin Thayer