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What's Driving This Year's Ambitious Tax Cuts?

Revenues are slowing but lawmakers, at least in red states, have continued to enact major tax cuts this year.

A warehouse full of bourbon. As part of its tax breaks, Kentucky is phasing out, over 18 years, the property tax on bourbon aging in barrels.
(Kelly vanDellen/Shutterstock)
When Congress sent $175 billion to states as part of the American Rescue Plan Act in 2021, one of the major strings attached was that the money could not be used for tax relief. More than 20 red states sued, contending this was an unconstitutional restriction.

They needn’t have worried. States have been cutting taxes nearly nonstop ever since.

No fewer than 43 states enacted tax cuts in 2021 or 2022, according to the Tax Foundation. With revenues starting to slow, recession fears on the rise and the federal largess starting to run out — along with the fact recent tax cuts have barely had a chance to kick in — states have been a little bit more hesitant about continuing to cut rates this year.

But not by much. Multiple states have passed legislation that will send hundreds of millions back to taxpayers. “We’ve seen 2023 as yet another banner year for state tax cuts,” says Jonathan Williams, chief economist at the American Legislative Exchange Council. “In our view, in many cases states are focusing on the right kind of taxes to cut, income and capital-based taxes.”

Some states passed highly specific reductions. Arkansas created a new sales tax exemption for qualifying data centers, while Kentucky decided to phase out, over 18 years, the property tax on bourbon aging in barrels. For the most part, though, states cut broad-based taxes, such as income and property taxes. No state this year has raised broad-based taxes.

Most but not all of the cutting this year has happened in red states. In North Dakota, GOP Gov. Doug Burgum didn’t get the flat personal income tax he wanted, but the Legislature reduced the number of brackets from five to two, while also reducing rates, as part of an income and property tax relief package totaling $515 million.

Montana passed a series of cuts and credits that will bring tax bills down by more than $750 million. Kentucky’s income tax reduction will drop revenues by $315 million, Tennessee’s corporate and sales tax cuts amount to $400 million and Idaho reduced property taxes by $355 million. “It is clear the tax-cutting fervor has not subsided and that relief has been, once again, the most prominent state fiscal trend in 2023,” according to Jackson Brainerd, a fiscal analyst at the National Conference of State Legislatures.

Not everyone is cheering. Most of the cuts will primarily benefit high-income earners, while of course reducing revenue that could address policies people want addressed such as college affordability and child care, says Aidan Davis, state policy director at the Institute on Taxation and Economic Policy. “If lawmakers choose to prioritize tax cuts, they have to deprioritize something else that could be benefiting their states,” she says.

Total state revenues dipped by 0.4 percent during the fourth quarter of 2022, compared to a year earlier, according to the Urban Institute. That translated into a 6.4 percent drop in real terms (which is to say, after inflation). Revenue collections slowed in both March and April, although overall states should meet or beat revenue expectations for the fiscal year, which ends for most on June 30. In New York, personal income tax receipts dropped nearly 50 percent in April, compared with last year. California is facing a projected $31.5 billion budget shortfall, a huge turnaround from its $55 billion general fund surplus last year.

“Those states implementing significant new spending plans or major tax policy changes could face additional budgetary pressure in the near and medium term, depending on the severity of revenue slowdowns,” according to Fitch, the credit rating agency.

Still, with rainy-day funds at record levels and many states enjoying sizable or even record surpluses, the always itchy political urge to cut taxes has remained irresistible, at least among Republicans. “It was always going to be hard to beat 2022, which was a generational high water for substantial, comprehensive tax reform,” says Williams, “but it was still an important year for tax cuts across the board.”

Not Done Yet

On Thursday, the Texas House gave preliminary approval, on a 140-5 vote, to a $16.3 billion property tax cut. With Texas sitting on a $33 billion surplus, cutting taxes — particularly property taxes — has been a priority for GOP Gov. Greg Abbott and legislative leaders. The state Senate has crafted a property tax cut of similar scope — $16.5 billion — but the two chambers remain far apart in terms of how to structure the relief. Abbott may have to call a special session to decide the matter.

It hasn’t always been easy for lawmakers to reach agreement. Major tax cut packages are still pending in Nebraska, North Carolina and Oklahoma. Williams says that states in the Midwest feel competitive pressure following Iowa’s switch to a flat income tax rate last year.

Iowa not only flattened but cut rates significantly, with the largest cuts being phased in over time. The plan reduced revenues by $236 million the first year, a sum that is set to rise to $1.9 billion five years from now. Iowa GOP Gov. Kim Reynolds signed an additional $100 million property tax cut measure earlier this month.

Knowing that good times can’t last forever, some states have cut taxes using triggers, requiring revenues to reach certain levels before they can be fully phased in. West Virginia, for example, approved a set of tax cuts that are expected to cost $114.6 million in the current year but rise to nearly $700 million next year.

Numerous states have also offered one-time rebates or credits. With Georgia’s rainy-day fund maxed out at its legal limit of $5.2 billion and the state enjoying a $6.2 billion surplus, lawmakers decided to give retroactive credits on 2021 and 2022 income taxes, sending out checks totaling $1 billion earlier this month.

“One of the major reasons why states are in such good position is because of the pandemic aid,” says Rebecca Thiess, manager of the Pew Charitable Trusts’ fiscal federalism initiative. “It is key for states as they are considering things like tax cuts to be aware of what’s behind their fiscal position, whether the dollars contributing to that are one-time in nature.”

Democratic Priorities

Last week, Minnesota legislators reached agreement on a package that will offer one-time rebates on personal income taxes, additional child-care credits and relief for some Social Security recipients, while raising taxes on corporations.

Minnesota is controlled by Democrats, who have generally been warier than Republicans about cutting taxes this year. Last month, Democratic Gov. Laura Kelly of Kansas vetoed a $1.4 billion tax cut measure passed by the GOP-controlled legislature. Kelly objected to the proposed move to a flat tax, favoring a one-time rebate instead.

Creating or increasing child tax credits is an idea with bipartisan appeal, approved this year in states including Maryland, New Mexico and Utah. Michigan, controlled by Democrats this year for the first time since 1983, approved increases to child tax credits and the earned-income tax credit, while making pension income tax-exempt. “Today, I am proud to sign a $1 billion tax cut for seniors and working families,” Democratic Gov. Gretchen Whitmer said in March.

Lawmakers from both major parties are aware that their current bounties won’t last forever. Even if the economy doesn’t fall into recession this year, the federal money will run out — or even be partially clawed back, if congressional Republicans get their way in the debt-ceiling debate.

But for now, it’s still a good time for state budgets and lawmakers have decided to let the good times roll.
Alan Greenblatt is the editor of Governing. He can be found on Twitter at @AlanGreenblatt.
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