Right now in Washington, D.C., Congress is debating whether to let the tax cuts they enacted in 2001 and 2003 expire. Much of the discourse has, rightly so, focused on the tax cuts’ effect on the federal budget and tax code. Earlier today, NTU released a letter from 313 economists, including a Nobel laureate, urging Congress to not let the tax cuts expire out of concern for the effect such inaction would have on individual and business taxpayers. As the letter states, “Robust economic growth is best served by a tax code that levies low and predictable rates. The promise of a tax increase in January 2011 would create significant economic distortions as individuals and businesses conserve capital or stave off hiring.” But policymakers should not focus exclusively on what will happen to the federal tax code. Congress would be wise to also consider the impact of the tax cuts’ expiration on the state tax codes as well.
As Stateline.org reported last week, more than a dozen states have tax codes that are connected to federal tax laws in ways that could drive revenues up or down depending on what Congress decides to do. If Congress decides to extend all of the tax cuts, then nothing happens; the tax codes remain the same and the states are no better or worse than they are right now. But if some or all of the tax cuts expire, some states will lose revenues while others will see revenues go up; at least two states, North Dakota and Oregon, could see both happen.
Nine states (Idaho, Minnesota, North Carolina, North Dakota, Oregon, South Carolina, Utah, and Vermont) will likely see increased revenues should some or all of the tax cuts expire. This is because, according to Stateline, these nine states collect taxes based on federal taxable income rather than adjusted gross income, so taxes, including those at the state level, will go up as the increased deductions at the federal level disappear. Several of these states, notably Oregon, are running huge budget deficits and would probably like to keep the increased revenue in their coffers rather than return it to taxpayers. Maine could also see increased revenues and taxpayers see as much as $500 million higher taxes if several federal tax credits expire, according to Maine Revenue Services.
Eight states (Alabama, Iowa, Louisiana, Missouri, Montana, North Dakota, Oklahoma, and Oregon) stand to lose revenues because they allow deductions of federal taxes paid from the state tax liability. On Monday, the chief economist for the Louisiana Legislative Fiscal Office told lawmakers that the state stands to lose $120 million in revenues if the tax cuts expire, just as the state has to address an estimated $2 billion budget gap. To deal with the revenue shortfall, states could reduce the amount deduction, but that is akin to a tax hike – on top of the federal one.
All of these states are watching to see what happens in Congress, but not all of them are sitting down. North Dakota, which has largely weathered the worst of the economic downturn thanks to manageable budgets and its energy industry, is trying to prepare for Congress not extending the tax cuts by working on legislation to limit the impact of the tax cuts expiration.
As the Stateline story suggests, letting the tax cuts expire would create serious upheaval in many states’ tax codes. It will also increase the complexity and the costs of compliance. As the economists’ letter noted, “According to a National Taxpayers Union study, individual taxpayers alone will spend 2.43 billion hours complying with income tax laws this year. This loss of time and associated costs (estimated at more than $100 billion) would only be made worse if policies such as the estate tax, “Pease limits” on itemized deductions, and the Personal Exemption Phaseout were permitted to return.” Additionally, the debate in Congress has left many, including the states, uncertain about who will pay what in taxes. Predictability is one of the factors that lead to strong economic growth, so Congress should not allow predictability to be lost with the expiration of the tax cuts.