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<i>The Week in Public Finance:</i> Why Low-Tax States Could Come to Dislike the New Tax Law, Too

Up until now, high-tax states have complained the most.

When Congress capped the state and local tax deduction at $10,000 as part of its tax overhaul late last year, it was mostly officials from high-tax states such as California, New Jersey and New York that cried foul. But new research shows that taxpayers in more than one-third of states -- some with relatively low income taxes -- could be negatively affected by the change.

In 19 states and the District of Columbia, the average taxpayer deducted more than $10,000 in state and local taxes, according to a report released this week by the Pew Charitable Trusts. It looked at tax returns from 2015 and found that the average deductions in those 19 states ranged from more than $22,000 in New York to just $10,121 in New Hampshire.

The report’s author, Phillip Oliff, says the data indicates that the new cap will affect filers in states all across the country. That runs contrary to popular sentiment that only high-tax states would be negatively impacted by the cap. Officials from those states have worried that limiting the deductability of state and local taxes could make it harder to raise tax rates in the future because taxpayers wouldn't be able to increase their tax deductions accordingly.

In addition to those high-tax states -- those in the Northeast and on the West Coast -- Iowa, Ohio, Nebraska and Wisconsin will also be affected by the new cap. Deductions for state and local taxes in these four states averaged between $10,000 and $15,000.

In many states, high property taxes are to blame. State and local property tax collections per capita in Iowa and Nebraska, for example, both rank in the top third, according to the conservative Tax Foundation.

Moody’s Investor’s Services predicts that the new tax law will slow home price growth in counties with the highest property taxes. Of the 25 counties where growth in home prices is projected to slow the most over the next 16 months, 21 are in Connecticut, New Jersey and New York.

Ironically, a slowdown in home prices could increase property tax rates even more because, according to Moody’s, “local governments facing slower home price appreciation will become more dependent on property tax increases to keep revenues in balance.”

Local income taxes also play a role. Pennsylvania and Ohio have relatively low state tax rates, but their localities also tax income. As a result, those states rank 11th and 16th, respectively, for local and state income tax collections per capita.

Still, there’s a lot that isn't known. For instance, states like California and New York have created policy workarounds that allow taxpayers to realize their full state and local tax deduction and avoid the $10,000 cap. And Iowa is considering legislation that would cut income tax rates, which would then lower taxfilers' average state and local tax deduction.

Meanwhile, the tax overhaul also doubled the individual standard deduction to $12,000, which may mean that some taxpayers who previously itemized their income deductions may start taking the standard deduction instead. “The standard deduction creates a wild card,” says Oliff. “We won’t understand the precise impact until folks start filing their taxes next year.”


In other public finance news this week:

Pensions Hurting Recruitment?

It’s becoming harder and harder to fill public-sector jobs. Just ask the states, such as Arizona and Oklahoma, that are dealing with a teacher shortage and protests for better pay.

A study this week suggests that one culprit to blame for this problem is less attractive pension benefits. According to the Center on State and Local Government Excellence, there has been a 71 percent increase in job openings since 2012, but the gap between job openings and hirings has continued to grow since then. Meanwhile, nearly all governments have cut pension benefits for new hires.

In most cases, they did this to help stabilize budgets and a growing debt load. But, notes the Center’s CEO Joshua Franzel, they have likely done so at the cost of becoming less competitive with the private sector.

“Given the current, increased focus on wage and benefit compensation for teachers, public safety professionals and many other public servants in a range of states,” Franzel says, “it is essential for reforms to be analyzed not only by their budgetary impacts, but also for their long-term public workforce development implications.”


Big Revenue Growth for States

States are expecting significant tax revenue growth over the next two years, according to a new analysis by the Rockefeller Institute of Government. On average, states are expecting a 4.4 percent increase in income tax revenue in fiscal 2018 and a 3.8 percent increase in sales tax revenue. That’s a big leap from 2017, which saw less than 2.5 percent growth in both categories.

Meanwhile, twice as many states expect more than 5 percent revenue growth in sales and income taxes, compared with last year.

States are forecasting similarly robust figures for fiscal 2019 as well. Still, the report’s author Lucy Dadayan cautions that the numbers are “highly speculative,” as the mad rush of taxpayers who prepaid their state and local taxes last year before certain tax breaks expired may have skewed expectations.

This appears in "The Week in Public Finance" newsletter. Subscribe for free.

Liz Farmer, a former Governing staff writer covering fiscal policy, helps lead the Pew Charitable Trusts’ state fiscal health project’s Fiscal 50 online resource.
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