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How the federal tax overhaul could reshape state budgets

Congress may have finished its tax overhaul last year, but for state governments, the scramble has just begun....

Posted: Jan 8, 2018 6:08 PM
Updated: Jan 8, 2018 6:08 PM

Congress may have finished its tax overhaul last year, but for state governments, the scramble has just begun.

No two states will be effected in the same way, and legislative budget offices across the country now face the daunting task of figuring out what the new law means for their budgets and their citizens' tax burdens.

The change may reshape the landscape of taxation as states look for new sources of revenue to make up for expected federal spending cuts, and to do so under a new system that could make raising local taxes more difficult.

"States are figuring out right now what the tax side is going to look like, but they're not certain what spending from the federal government they're going to end up getting," said Kim Rueben, director of the State and Local Finance Initiative at the Urban-Brookings Tax Policy Center. "So it's going to be another year where a lot of the uncertainty with the economy has to do with the uncertainty in Washington."

Although state and federal tax laws are separate, state tax systems often adopt parts of the federal system through a process called "conformity." That means they adjust automatically to changes in certain provisions of the tax code, to reduce administrative complexity.

Even though the new federal law will lower taxes for most filers by doubling the standard deduction, among other provisions, it also broadens how much of a filer's income is subject to tax because it gets rid of so many itemized deductions. So to the extent a state uses federal taxable income or federal adjusted gross income (AGI) as its base, more of its residents' income will be subject to state tax.

Related: The great debate: Will corporate tax cuts trickle up or trickle down?

"For most states, they're going to see some sort of increase in revenue, and they will be deciding how to use that revenue," said Nicole Kaeding, an economist with the Center for State Tax Policy at the Tax Foundation. "Do they increase their spending, or do they lower their taxes?"

Historically, Kaeding said, states have reacted to federal tax changes like these by cutting taxes, and she expects this time to be no different. Indeed, several states have already moved to "decouple" from the federal tax code.

In the days after the federal tax law passed, Republican Maryland Governor Larry Hogan announced his intention to offer legislation that would prevent the state from collecting about $100 million in extra taxes as a result.

However, people who favor stronger government services aren't so eager to give the money back to taxpayers. States spend about a third of their budgets on education, a third on healthcare and help for the needy, and a third on everything else, from law enforcement to infrastructure. Those budgets took a big hit during the recession and have remained under pressure due to aging demographics and a shift to e-commerce, which has depressed sales tax collections.

Benjamin Orr, executive director of the Maryland Center on Economic Policy, a liberal public policy nonprofit, worries about Congressional Republicans' plans to follow tax reform with cuts to federal programs - particularly Medicaid - which make up about third of state revenues. Maryland is particularly affected by federal spending reductions because so many federal workers live there, and reductions in headcount at federal agencies headquartered in the state - like the Social Security Administration, Food and Drug Administration, and National Institutes of Health - could be a big hit to employment.

"This one-two punch is why we believe that Governor Hogan's proposal to cut state revenues is shortsighted," Orr said. "when what Maryland is actually going to have to do is pick up the slack."

Similar conversations are playing out in other states. In addition, high-tax states like California, New Jersey and New York are trying to figure out how to mitigate the impact of one of the most controversial changes in the federal tax overhaul, which puts a $10,000 cap on the state and local taxes that filers may deduct on their federal returns. That change alone could make it harder for such states to get voter support for higher taxes in the future.

Related: How high-tax states may try to get around the new SALT cap

"My fear is that the tax plan is going to be used as an excuse to not do the things that New Jersey needs to do," said Jon Whiten, vice president of New Jersey Policy Perspective, a left-leaning non-profit. "If you look down the road, assuming the anti-tax argument wins the day, and we're constrained in our ability to raise more, the state and local governments will be squeezed at both ends."

There may be some options for raising new revenue, like raising gas taxes. Corporate taxes are also still fully deductible from state taxes, and since companies will still be paying far less overall, they may not object too strenuously to heftier state taxes.

Meg Wiehe, deputy director of the left-leaning Institute on Taxation and Economic Policy, said she's noticed a trend over the past year toward more aggressive taxation of companies and high-income people, ever since Kansas backtracked on a high-profile experiment with eliminating taxes on pass-through companies that led to a plunge in revenue.

Despite the challenges posed by the cap on the state and local tax deduction, she still favors boosting individual income taxes as the most stable and predictable way to raise revenue without changing how the economy functions.

"This is an opportunity for lawmakers and advocates to put out a really strong argument for why raising revenue through a personal income tax makes the most sense," Wiehe said. "The top 1% of their states can certainly afford that, now that they've gotten a break through the federal tax changes."

Mississippi Coronavirus Cases

Data is updated nightly.

Confirmed Cases: 119336

Reported Deaths: 3328
CountyConfirmedDeaths
Hinds8109180
DeSoto734280
Harrison553785
Jackson488488
Rankin412386
Madison388094
Lee368682
Forrest313478
Jones298484
Washington2644100
Lauderdale2611135
Lafayette256043
Lamar234040
Oktibbeha206055
Bolivar205279
Neshoba1883111
Lowndes182862
Leflore173088
Panola172241
Sunflower165949
Warren156656
Monroe154873
Pontotoc151520
Marshall150530
Lincoln144859
Pike140956
Copiah139936
Scott128129
Coahoma126537
Union126025
Yazoo124534
Simpson124049
Grenada123139
Tate123039
Pearl River117960
Itawamba117827
Leake117042
Holmes115160
Adams110245
Prentiss109520
Alcorn105012
Wayne103422
George103020
Covington99729
Marion96944
Tippah95124
Hancock88128
Newton88128
Chickasaw87028
Winston85921
Tallahatchie85826
Tishomingo83141
Attala80927
Clarke78353
Clay71522
Jasper69817
Walthall64827
Calhoun63613
Smith60816
Noxubee60317
Yalobusha56616
Montgomery56523
Lawrence55314
Claiborne54216
Tunica53917
Perry52823
Carroll50912
Stone49814
Greene48218
Humphreys45817
Amite43413
Jefferson Davis42412
Quitman4246
Webster38213
Benton36911
Wilkinson34321
Kemper33415
Sharkey29115
Jefferson28110
Franklin2533
Choctaw2096
Issaquena1074
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Alabama Coronavirus Cases

Confirmed Cases: 162720

Reported Deaths: 2735
CountyConfirmedDeaths
Jefferson23940385
Mobile17123319
Tuscaloosa10602141
Montgomery10503199
Madison955798
Shelby760565
Baldwin676869
Lee664965
Calhoun476562
Marshall447451
Etowah441952
Morgan430835
Houston423934
DeKalb355429
Elmore327858
St. Clair311342
Limestone297031
Walker287493
Talladega276437
Cullman266525
Lauderdale240543
Jackson225317
Autauga212631
Colbert210232
Franklin209432
Blount200925
Russell19833
Chilton192332
Dallas189227
Dale184952
Coffee183611
Covington177329
Escambia175831
Clarke138717
Chambers138047
Tallapoosa137287
Pike136414
Marion110931
Barbour10559
Marengo104622
Butler101941
Winston94713
Geneva9427
Pickens89018
Lawrence88533
Bibb86115
Randolph84616
Hale78130
Cherokee76414
Clay76312
Washington75812
Henry7316
Lowndes72128
Monroe66310
Bullock65117
Crenshaw61230
Fayette59913
Perry5996
Cleburne5799
Conecuh57213
Wilcox57112
Macon54320
Lamar5235
Sumter48621
Choctaw39512
Greene34516
Coosa2173
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