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Idaho Gov. Brad Little proudly stood before an appreciative crowd at a software company recently and signed a record $600 million tax cut into law.
The cut includes $350 million in one-time rebates and $250 million in permanent income tax reductions for individuals and businesses. It lowers the top rate on individuals and corporations from 6.5% to 6% while reducing the number of individual brackets from five to four.
For Idahoans, it is the second consecutive round of good tidings from the state, which passed a $383 million tax cut in 2021 consisting of $220 million in one-time rebates and $163 million in permanent relief. At this point, Idaho can afford it with a $1.9 billion budget surplus.
Idaho is hardly alone. An analysis of state finances by Richard Auxier, a senior policy associate at the Urban Institute and Brookings Institution’s Tax Policy Center, released Feb. 9 found 29 states and the District of Columbia enacted significant tax cuts in 2021.
Maryland Gov. Larry Hogan in January announced a budget that includes a record $4.6 billion tax cut, the centerpiece of which is a six-year plan to eliminate income taxes on state residents over 65.
In Mississippi, the state House and Gov. Tate Reeves are proposing to eliminate the income tax, while the state Senate has unveiled a more modest proposal to trim the income tax and lower some other fees.
“We’ve seen a large range of tax cuts, both in Democratic and Republican states,” says Brian Sigritz, director of state fiscal studies at the National Association of State Budget Officers. “It’s not uncommon coming out of a downturn. The overall fiscal situation we’re in right now is unique.”
Fitch Ratings, which monitors state bond issuance, said in October that more than a third of states incorporated some type of tax relief into their final fiscal year 2022 budgets.
The states find themselves in the unusual position of being flush with cash. As of December, total state tax revenues increased 26.3% from April of 2021, when compared to the same period a year earlier, according to Lucy Dadayan, senior research associate at the Tax Policy Center.
Personal income taxes rose 21% overall, while corporate income taxes increased 62.7% and sales tax revenue grew by 23.7%. All 45 states for which data is consistently available saw growth in their tax revenue, with 24 states enjoying increases of more than 20%, Dadayan says.
What’s behind the boom?
Ironically, it is largely the result of the two-year-old coronavirus pandemic, which nonetheless wreaked havoc on the overall U.S. economy. Massive amounts of federal stimulus stoked consumer demand, which had people stuck at home ordering items online. Internet sales are now captured more thoroughly by states, providing them with greater sales tax revenues.
As consumers shifted their consumption during the pandemic from services like getting their hair done to purchases of big-ticket items like refrigerators, states prospered as goods are taxed more than services, which many states exempt from sales taxes.
The pandemic also hurt workers in service industries like restaurants and hotels, who typically are at the lower end of the earning curve, but spared many high-income earners who instead of going into the office were able to work from home, continuing to draw salaries that could still be taxed.
The runup in the stock market, along with a wave of companies going public for the first time and making millionaires of their workers who were compensated with stock options, led to massive increases in income taxes in states that have progessive tax systems.
Finally, as tourism recovered in states like Nevada and Hawaii, along with rising energy prices that benefited states that are heavily reliant on gas and energy-related taxes, revenues rose.
This resulted in states going from a position of fearing the worst in the spring of 2020 to having a lot to celebrate in 2022. In California, where Gov. Gavin Newsom forecast a $54 billion budget shortfall in May, 2020, two months into the pandemic, the state is now looking instead at a surplus of $45 billion.
But Dadayan says that despite the rosy budget picture the states find themselves in, some caution is warranted. Inflation is running rampant, the U.S. economy is slowing down and a lot of the reasons for the strong growth in state revenues are not likely to continue. In particular, many states have aging demographics and there has been a sharp decline in commercial property values, which could affect the property taxes collected from businesses.
“There are so many uncertainties right now and the spending pressure should be taken into account,” she says.
Then there is the question of equity. Auxier studied how four states – Arizona, New Mexico, Ohio and Maryland – handled tax cuts in 2021 and who received the most benefit from them. Arizona and Ohio favored income tax cuts while Ohio and Maryland chose to prioritize the earned income tax credit, which provides a state income tax credit on top of the federal credit available to low-income workers.
His conclusion? “In Arizona and Ohio, households earning more than $100,000 received an overwhelming share of the tax cut benefits. In stark contrast, by expanding their state EITC (and making a few other changes), New Mexico and Maryland distributed nearly all their tax relief to households earning less than $30,000.”
In Arizona, households earning more than $100,000 received 93% of the benefits. In Ohio, that number was 73%. In contrast, expansions of the state earned income tax credit yielded benefits to low-income residents. Those earning less than $30,000 in New Mexico received 91% of the benefits, while in Maryland it was 81%.
“The fiscal situation in 2022 is a complex mix of opportunity, uncertainty and responsibility,” Auxier wrote in his analysis. “Federal fiscal assistance was unprecedented but is coming to an end. The current tax revenue surpluses are large but possibly not sustainable. The economic consequences of the ongoing pandemic are highly uncertain and unequal.”
Many states considering tax cuts this year are also offering other breaks to residents, ranging from delaying planned increases in state gasoline taxes to investments in education and the environment. Some are making one-time payments to health care workers and others who bore the brunt of the pandemic.
In Illinois, for example, Gov. J.B. Pritzker on Feb. 2 announced a budget proposal that includes about $1 billion in tax relief. The plan includes a one-year elimination of a 1% sales tax on groceries, freezing the state’s gas tax at its current rate for one year, and one-year waivers on health care worker and liquor license fees, and a one-time property tax rebate.
“The Family Relief Plan can’t solve all the challenges of global inflation, but we can do our part to alleviate some pressure on Illinois’ working families,” said Pritzker.