The Week in Public Finance: Tax Reform Isn't Over -- Here Come the States

States are exploring tax changes in response to the federal overhaul. The proposals in Iowa and New York this week may just be the tip of the iceberg.
by | February 16, 2018
Iowa Gov. Kim Reynolds proposed cutting state income taxes by as much as 23 percent this week. (David Kidd)

The implications of the federal tax overhaul are keeping state lawmakers busy this year in what would otherwise be a quiet, election-year legislative session. This week, two governors proposed major tax changes of their own.

In New York, Gov. Andrew Cuomo announced his plan to help taxpayers avoid the $10,000 limit on state and local tax (SALT) deductions imposed by the new federal tax law. Like other high tax states, the average itemized deduction in New York is more than twice the federally capped amount.

To get around the cap, Cuomo is proposing a payroll tax, which is still deductible under the new federal rules. It would be optional and function like this: Instead of workers paying state income taxes, employers would take the equivalent amount of money out of a worker's wages. Businesses would then pay a payroll tax on those lower wages and deduct it from their federal taxes. The employee would have a lower income to declare to the IRS and would effectively receive the same take-home pay while saving the same amount on taxes as they did under the old system.

Meanwhile, in Iowa, Gov. Kim Reynolds unveiled her plan for major cuts -- as much as 23 percent -- in state income taxes. She also wants to simplify the state tax code and lower taxes for middle-class Iowans and small business owners. Reynolds’ office estimates the plan would cut income taxes by $1.7 billion over four years while maintaining expected growth in state revenue.

The proposed changes were spurred, in part, by a provision in Iowa's tax code that allows Iowa taxpayers to deduct what they paid in federal income taxes from their state tax liability. It creates an inverse relationship with federal taxes, whereby Iowans federal taxes will go down, but their state taxes will go up.

Cuomo and Reynold's proposals are the latest in a slew of tax policy discussions percolating in statehouses this winter. Iowa is one of the few considering more wide-ranging changes. Most other states are mainly focused on avoiding a tax hike thanks to the particulars of the federal tax overhaul.

That's true in California, Connecticut and Maryland, where, like New York, officials are contemplating SALT workarounds. Their proposals would allow for tax deductible charitable contributions to special state funds in lieu of a traditional state tax payment. And in Michigan, lawmakers reached a deal this week to add back the state's personal exemption deduction, which was zeroed out under the new tax law in favor of a higher standard deducation. Since Michigan's tax code is tied to the federal tax code, its personal exemption was also zeroed out. Unchanged, it could have cost Michiganders more than $1 billion.

Another problem states are facing -- much like Iowa -- is what to do, if anything, about increased revenues. The changes to the federal income tax code eliminated a number of tax deductions, resulting in a broadening of the tax base. The reduced federal tax rates offset those changes at the federal level. But at the state level -- without intervention -- the provisions will result in more revenue. So far, 17 states have said they expect to see a few hundred million in additional revenue in the next fiscal year. Two -- Montana and Oregon -- could see slight revenue drops of around $40 million. And three -- Georgia, Minnesota and New York -- would approach $1 billion in additional revenue.

Still, it remains to be seen how far states will get with proposals that require more than shifting around tax definitions. For instance, Republicans in New York have already panned Cuomo’s legislation as being too complicated. And the short time frame -- most state legislative sessions run just two more months -- makes it difficult to hammer through anything that may require buy-in from lots of stakeholders.

Nicole Kaeding, a state tax policy expert at the nonpartisan Tax Foundation, notes that while several states are trying to get out in front of the changes the tax code brings, most states are adopting a wait-and-see approach. “A lot of them are still in this place of estimating and trying to get their minds around what changes will look like,” she says.

 

Other headlines in public finance this week:

Congress Looks to Amend Federal Tax Reform -- Already

U.S. Reps. Randy Hultgren and Dutch Ruppersberger introduced legislation this week to bring back a type of refinancing bond eliminated under the new federal tax law. The so-called advanced refunding bonds make up a relatively small part of the municipal market. But Hultgren, who outlined the bill at the National Association of State Treasurer’s conference this week in Washington, D.C., said the bonds still represent important savings for many issuers. For instance, the Elgin Community College in Illinois saved $240,000 using advance refunding bonds in 2012. “That’s a couple teachers, security,” Hultgren said. “That’s significant to a place like Elgin Community College.”

 

Payday Lenders Gaining Ground?

Ever since new federal rules regulating payday lenders were finalized last year, the high-interest, short-term loan industry has been working furiously to counteract them. This week, the House of Representatives passed the so-called Madden bill, which could create a workaround in the 15 states that cap interest rates for short-term loans. And in Florida, a legislative subcommittee approved a bill that would allow payday lenders to provide longer-term loans for more money.

Consumer protection organizations such as the Center for Responsible Lending have warned that these changes “would spring a debt trap” for millions of low-income Americans.

This week’s developments follow a previous blow to consumer protection organizations: In December, Mick Mulvaney, Trump’s budget director, took over the Consumer Financial Protection Bureau and immediately set about reopening the federal payday lending rules.

 

Feds Pass the Buck on Infrastructure

President Trump unveiled his infrastructure plan this week and, as Governing’s Dan Vock reported, it puts much of the financial reliance on state and local governments and the private sector. In exchange, states could get help building those projects more quickly. Ratings agencies said this week that the shake-up could be a big positive, particularly when it comes to letting state and local governments innovate and attracting private investment. However, as S&P Global Ratings notes, “the problem for U.S. infrastructure has never been a shortage of private capital, but rather how to pay for it. The question is, will Americans accept paying more to use the nation's infrastructure?”

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