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By Che Odom
President Donald Trump and the GOP-controlled Congress will likely make drastic tax changes at the federal level, creating a lot of unknowns for states as they enter budget-setting time.
Generally speaking, states must decide their spending and tax plans before Congress will act to possibly lower individual and corporate income taxes, as well as broadening the tax base and potentially eliminating deductions for state and local taxes.
Losing the deductions would leave states, at least half of which already face budget shortfalls, with few options for taxes to raise. especially when there is little political will to raise income taxes.
“Too many states are leaning heavily on regressive sales and excise taxes to balance their budgets, or to fund cuts in progressive income taxes and estate taxes,” Carl Davis, Institute on Taxation and Economic Policy’s research director, told Bloomberg BNA.
Raising taxes and cutting spending are the options for states in dire straits. The straightforward options are made difficult, considering the various factors at play.
Oil and mineral prices could increase, creating more revenue for states that lean heavily on severance taxes. A lower federal corporate income tax could actually mean more money for states following the federal code if deductions and exemptions are limited, broadening the tax base.
But elimination of the federal deduction for taxes paid to states could hurt states such as California and New York with higher income tax rates, and repeal of the Affordable Care Act could accelerate Medicaid burdens on states.
“State tax systems and spending are really reliant on what federal government does,” Kim Rueben, senior fellow at the Urban Institute’s Tax Policy Center, said during a webcast Jan. 26. “As we change the federal tax system, it is going to change what states do.”
State budgets are growing more slowly than a decade ago, according to John Hicks, executive director of the National Association of State Budget Officers. Thirty-nine states have lower spending, when adjusted for inflation, than they did 10 years ago, and half of the states have had back-to-back years of budget shortfalls, he added.
“We haven’t seen that since the great recession,” Hicks said during the webinar.
Economic forecasts were overstated, and sales and income taxes were weak, he said. States will need to be more reserved, particularly given the uncertainty of what to expect from the federal government, pension burdens growing and the likelihood of Medicaid funding cuts, he said.
Economic growth is the key driver of state revenue, Joseph Henchman, the Tax Foundation’s vice president of legal and state projects, told Bloomberg BNA.
Before the 2000s, state revenue grew at 7 percent or 8 percent a year because the economy overall was growing at 3 percent or 4 percent each year, he said. Now, economic growth is around 1 percent or 2 percent a year, he added.
“It’s no surprise state revenue growth has been hit,” Henchman said. “Some states are still coming to grips with this, that they can’t have automatic 7 percent budget increases every year. People spend a lot of time focused on distribution when talking tax policy, but the focus really needs to be on what grows the economy.”
As states grapple with budgets, positive signs may be on the horizon, Joe Crosby, a state tax policy expert and principal at MultiState Associates, told Bloomberg BNA.
“The strength of the equity markets at the end of 2016 may result in an ‘April surprise’ when final personal income tax payments are made,” he said.
Additionally, indicators suggest the economy is adding more jobs, and wages are growing a bit faster, he said.
For states such as Alaska, Wyoming, North Dakota, Texas and West Virginia that rely on severance taxes, prices for natural resources have rebounded somewhat, which appears to be on an upward trend, he said.
“With six months of revenue reports remaining in most states’ fiscal years, revenue improvement may still be forthcoming,” he said. “And, with the exception of a few states that have been very hard hit, most legislatures will be able to balance their current budgets with relatively modest revenue and spending adjustments.”
To contact the reporter on this story: Che Odom at COdom@bna.com
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