Why State Leaders From Both Parties Are Cutting Taxes

This story was originally posted by Stateline, an initiative of the Pew Charitable Trusts.

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Both Republicans and Democrats are calling for state tax cuts this year, spurred by huge budget surpluses.

State leaders have so much money to spend this year—and are so eager to put dollars into people’s pockets as inflation rises—that even governors who’ve previously backed some tax increases, such as Illinois Democratic Gov. J.B. Pritzker, are now calling for tax breaks.

Pritzker wants to freeze the gas tax for a year, suspend grocery taxes for a year and give property owners a rebate up to $300. He said during his State of the State speech this month that the plan “can’t solve all the challenges of global inflation, but we can do our part to alleviate some pressure on working families.”

But the size and scope of this year’s tax changes will depend on the party in power in each state. Republicans tend to favor bigger, broader cuts, which they claim will turbocharge the economy. Democrats tend to favor more targeted tax cuts and credits aimed at middle-class or low-income people.

The partisan divide is on display in states such as Iowa. Lawmakers there are looking for ways to spend a $1.24 billion surplus and almost $1 billion in reserves from last fiscal year, plus an expected 3% revenue increase this year.

To put that in perspective, the entire budget last year totaled $8 billion.

Republican Gov. Kim Reynolds wants to gradually eliminate Iowa’s nine income tax brackets and instead charge everyone a flat 4% tax. She also wants to cut corporate taxes and eliminate taxes on retirement income. The GOP leaders of the House and Senate have proposed similar changes.  

“Ultimately, we’ve over-collected taxes to the tune of several billion dollars,” said Senate Majority Leader Jack Whitver. Republicans want to give some of those dollars back to Iowans and get them circulating in the economy, he said. 

The latest tax cut proposals build on cuts enacted in recent years, Whitver said. He said the proposed reductions will help Iowa compete with other states.

“The competition is fierce for citizens and for jobs,” he said. “And we want to make sure that Iowa is looked at as a pro-growth state.”

Democratic lawmakers, meanwhile, warn that Reynolds’ plan would disproportionately benefit wealthy residents.

“I’m not suggesting that some kind of a tax change isn’t in order,” said state Sen. Pam Jochum, the assistant Democratic leader. “But it needs to be focused, and it needs to be focused on putting more money in the pockets of working-class families.”

Under the Senate’s proposal to move to a 3.6% flat tax and end retirement income taxes, people who earn about $10,000 in taxable income would save 28 cents a week by 2028, Jochum said. Millionaires, in contrast, would save $1,400 per week.

Despite GOP claims in many states, researchers haven’t drawn a conclusive link between state tax cuts and economic growth.

“There’s dozens of papers written on this, with every imaginable result. [State tax cuts] help, they hurt, they do nothing,” said William Gale, co-director of the Urban-Brookings Tax Policy Center, a partnership between two Washington, D.C., think tanks. “That’s the sign of a literature where there’s just not clear effects.”

And while states have money to spend on tax cuts now, it’s unclear how long that’ll last. Revenue growth will likely slow starting in calendar year 2024, said Michael D’Arcy, director of U.S. Public Finance at Fitch Ratings, a global credit rating agency.   

Lawmakers who enact major tax cuts now, or cut taxes from a weaker fiscal position, risk creating future problems, he said. “They may start to experience some real challenges in balancing their budgets.”

Fairness Fights

Thanks to unexpected economic growth and federal COVID-19 aid, states have since the beginning of the pandemic collected billions more taxpayer dollars than budget writers anticipated. Those surpluses have persuaded many state leaders to propose tax cuts.

“Last year was a huge year for tax reform and tax relief, and if anything, 2022 is shaping up to be even bigger,” said Jared Walczak, vice president of state projects with the Center for State Tax Policy at the Tax Foundation, a conservative-leaning think tank based in Washington, D.C.

Sixteen states cut income taxes last year, Walczak said. This year, there are so many tax proposals it’s hard to keep track of them. 

“We’re seeing proposals to trim individual and corporate income taxes, to trim sales taxes, to provide property tax relief, to change different aspects of business taxation, even in some cases to reduce gas taxes,” he said. 

Many of the proposals—such as grocery and gas tax cuts and freezes—are bipartisan or cropping up in both Republican and Democratic-leaning states. But there are some differences.  

More red-state leaders are calling for across-the-board, permanent income tax cuts. Of the 16 states that cut income taxes last year, 12 have both Republican governors and Republican majorities in the state House and Senate.   

This year, South Carolina Gov. Henry McMaster, a Republican, wants to cut income tax rates for all brackets by 1 percentage point. The Republican leaders of the Indiana House want to cut income tax rates from 3.23% to 3% and cut several business taxes.

The GOP-controlled Mississippi House has passed a bill that would phase out income taxes and reduce sales taxes on groceries and vehicles. (The bill would raise taxes on other goods and services, such as alcohol and digital products.)

Blue-state leaders have tended to call for more targeted or temporary measures, such as Pritzker’s proposed tax holidays.  

New York Democratic Gov. Kathy Hochul wants to speed up previously enacted tax cuts for households earning between $26,000 and $300,000 a year, for instance. Maryland Gov. Larry Hogan, a Republican who leads a left-leaning state, has proposed a mix of retirement tax cuts, expanded tax credits for low-income families and economic development incentives.

New Mexico Democratic Gov. Michelle Lujan Grisham wants to cut the sales taxes rate by 0.25 percentage points and eliminate taxes on Social Security. But in New Mexico, as in Iowa, Republican and Democratic lawmakers have clashed over how tax cuts should be targeted.

A GOP-led House bill recently stalled in committee, opposed by Democrats who argued it would benefit wealthier state residents. Social Security benefits for the lowest-income older residents aren’t taxed under current New Mexico law.

“This for me is a question around equity, and who needs the resources the most,” Democratic Rep. Kay Bounkeua said during the hearing. 

An identical Senate bill endorsed by the governor and sponsored by Democratic state Sen. Michael Padilla is still under consideration. Padilla said he may narrow it to get it passed. “I may bring some caps on who is going to be able to utilize it, so we truly do focus on the middle-income and lower-income classes, or groups of people.”

Will It Last?

Democrats and some Republicans also have questioned whether their states will be able to afford large tax cuts in years to come. Lowering taxes can make it more difficult for states to pay for services such as education and health care.

Indiana Gov. Eric Holcomb, a Republican, declined to endorse the House income tax cut plan during a January news conference. He said his team was “open-minded,” but that he wanted to get a more accurate picture of both the proposal and the state’s fiscal situation. 

In general, state revenues have been hard to predict since the pandemic began. Budget writers are still trying to tease out the effect that rounds of federal COVID-19 relief aid for businesses, families and state and local governments has had on economic growth.  

All that volatility makes it riskier to make big tax changes now, D’Arcy of Fitch Ratings said. “When you make big policy changes in that kind of environment,” he said, “you’re adding policy volatility to all the other volatility, and you’re increasing your chances of getting some very unexpected results.”

Inflation adds to the uncertainty, he noted. Lawmakers may find that it costs more to pay for services than it did a few years ago.

Yet some states have passed large tax cuts anyway. An Arkansas law enacted in December that cut individual and corporate income taxes and created a low-income tax credit will cost the state about $500 million a year by fiscal 2026, D’Arcy said.

Even if the economy keeps growing and tax collections keep rising, the Arkansas law could still lead to a 6.25% drop in revenue that year, D’Arcy estimated.

In Iowa, Democrats say the GOP tax cut proposals will be far too expensive. The Senate’s income and retirement income tax cut proposals alone could cost $1.8 billion by 2028, Jochum said.

“You tell me how we sustain our budget, long term. I mean, really,” she said. “There’s no common sense in this.”

Tax-cut supporters aren’t too worried, particularly given the short-term economic forecast. Iowa has a huge surplus despite recent tax cuts, Whitver said.

“It’s cutting taxes, but it’s also controlling our spending,” Whitver said. “The states that I think have had struggles with tax reform—they didn’t control their spending.”