Tax Reform and Uncertain Economy Driving State Budget Proposals

It's a big election year, and legislative agendas won’t be focused on raising revenue.
by | January 24, 2018
The California state Capitol (TNS/Gary Coronado)

With 36 governors either entering their final year in office or running for re-election, ambitious tax policy proposals aren't likely to headline this year's legislative agendas.

Still, there's a lot to be done.

The federal tax overhaul, budget deficits, and the rising cost of health care and higher education have emerged as key issues as states kicked off their legislative sessions this month.

 

The Federal Tax Overhaul

For starters, several governors and state legislatures are looking at tax policy workarounds now that the state and local tax deductible has been capped at $10,000. California Senate President Pro Tem Kevin de León is shopping a proposal that would allow taxpayers to pay part of their state tax bill as a tax-deductible charitable contribution to the general fund. Maryland Democrats have proposed a package of bills that, among other things, creates a state-run charity to benefit public schools. And in New York, Gov. Andrew Cuomo has proposed implementing a payroll tax, which is deductible for employers, to offset a reduced income tax.

Of course, the federal tax overhaul isn't bad news for everyone. Some states may soon see a financial windfall. Several governors have already said they don't want the extra money: Officials in Michigan and New Jersey are looking at tax code changes to offset potential tax hikes for residents. Some states, though, are looking forward to the revenue increase. In Colorado, the expected $200 million windfall has already set off a debate among lawmakers about how to spend it. And with 25 states entering January with a budget deficit, the new revenue could help.

That said, there still remains a lot of uncertainty regarding how exactly the new federal tax law will affect taxpayer behavior and -- subsequently -- state coffers. "We're all just kind of watching to see how states are going to proceed in this uncertain environment in the upcoming year," says Gabriel Petek, managing director at S&P Global Ratings. He notes that California's budget doesn't even try to estimate how the new tax law will impact revenues; it cites too many unknowns.

 

Health Care and Higher Education

Elsewhere, health care and education -- two of states' biggest spending categories -- are being targeted for cuts or cost control measures. Maryland and New York have proposed reining in health care spending, and Rhode Island Gov. Gina Raimondo is proposing new copays for Medicaid clients.

Under education, a few are trying to tackle the rising cost of college. In West Virginia, Gov. Jim Justice urged lawmakers to "find a way to make our community and technical colleges free," and is pushing a plan for high school students to earn an associate's degree before they graduate. Cuomo also wants free college and has proposed extending New York's millionaire's tax by three years to cover state college tuition for qualifying low- and middle-income students. And in Delaware, Gov. John Carney and lawmakers are already working on legislation to create a student loan forgiveness program for educators as a way of retaining teachers in some of the state's highest-need schools and subject areas.

Meanwhile, Gov. Sam Brownback and leaders in the Kansas Legislature are sparring over the governor's five-year school funding proposal. Brownback has only appropriated two years' worth of funding. The proposal, which ironically relies on a two-year $1.2 billion tax hike lawmakers passed on an override last year after Brownback's veto, prompted Sen. Majority Leader Jim Denning to quip that Brownback "must not [have] got the memo that we don't print money in Kansas."

 

Pension Reform

Beyond tax workarounds and spending cuts, pension reform will be a divisive subject in at least two states this year. In Colorado, thanks to more conservative assumptions, the system's new funded ratio of 58 percent is even lower than it was during the recession. In Kentucky, home to some of the worst-funded pensions in the country, Gov. Matt Bevin has proposed a budget that fully funds pension plans to the tune of about $3.3 billion over the next two years. But Bevin's massive cuts to pay for that plan have many stakeholders concerned that the budget will underfund critical needs.

And finally, many governors also want to set aside more money in state rainy day funds. The push to save underscores worries from many lawmakers -- who well remember the toll the recession took on state budgets -- that the current economic expansion won't last. Now in the ninth year of recovery, the expansion is approaching the longest on record.

California Gov. Jerry Brown, who is seeking to preserve his legacy of bringing fiscal stability to the state, has proposed a $5 billion infusion into the state's rainy day fund. Governors in Arkansas, Colorado, Idaho and Maryland are also pushing for deposits into state reserves.