Blue and red states slash taxes despite warnings of hard times ahead

This story is republished from Stateline. Read the original article.

With a $750 million budget surplus on hand, there was little doubt whether North Dakota lawmakers would cut taxes earlier this year—the question was how much.

“The surplus was strong, and we believe it’s going to be sustained into the future,” said state Rep. Craig Headland. “So, it just made sense to cut taxes.”

Headland was among the Republicans who negotiated terms of the legislature’s $515 million tax cut this year—70% of which came from lowering personal income tax rates. The cuts leave North Dakota with the lowest tax rate among the states that collect income taxes.

In a special session this week, the legislature is considering more tax cuts that would exempt about 50,000 North Dakotans who earn $60,000 or less from income taxes. And Republicans, who control both chambers and the governor’s office in North Dakota, plan to continue their march toward eliminating the state income tax; Headland said he plans to introduce such a bill when the legislature reconvenes in 2025.

“Those revenues are there,” he said. “We certainly could do more tax relief.”

It’s not just red states that are slashing taxes.

In reliably liberal Massachusetts, Democratic Gov. Maura Healey just celebrated passage of the first tax cuts the state has seen in more than 20 years. Estimated to cost about $1 billion over the next four years, the changes will reduce estate taxes and capital gains taxes while expanding child and family tax credits and earned income tax credits.

Signing the legislation in Springfield earlier this month, Healey framed the cuts as a means of combating rising prices that have forced working parents to choose between the benefits of work and the costs of child care. The increasing cost of living in Massachusetts pushes young adults to leave the state, she said, and prevents renters from saving enough for a house down payment.

“Everyone feels the pinch,” Healey said, “and our future starts to shrink.”

Flush after years of thriving economies, states this year have continued a yearslong trend of tax cutting. Strong consumer spending, increasing property values and inflation have boosted state revenues along with an influx of billions from the federal government.

Many lawmakers view tax cuts as a logical response to boom times: returning excess taxpayer dollars to taxpayers. But some experts think states have cut too deep, using short-term revenue trends to justify permanent reductions in state revenue, often through cuts that benefit the wealthiest residents. And they warn that some states already are starting to bring in less money.

So far this year, at least 15 states have cut income taxes, according to the Institute on Taxation and Economic Policy, a liberal tax policy nonprofit. Since 2021, half of all states have cut personal income tax rates, according to the Tax Foundation, a conservative-leaning tax policy nonprofit.

State tax cut measures vary wildly. Many have slashed income tax rates across the board. Other states have implemented more targeted measures or relied on so-called revenue triggers, which usher in tax cuts or rebates if state revenues reach certain benchmarks.

Oregon, for instance, will return a record $5.6 billion to taxpayers through the state’s “kicker,” which is triggered when state revenues exceed official projections by at least 2%. The current state windfall means Oregon will credit taxpayers an average of $980 on their 2023 personal income tax returns when they file next year, according to the state Office of Economic Analysis.

“We really are in the midst of a tax-cut wave right now,” said Wesley Tharpe, senior adviser for state tax policy at the Center on Budget and Policy Priorities, a research and policy institute that advocates for left-leaning tax policies.

Tharpe said the wave resembles those that followed economic booms in the 1990s and in the years following the Great Recession of 2008, though states now are cutting deeper than ever before. The current trend may leave states with less money on hand for education and health care, the top drivers of state spending, Tharpe said.

Additionally, many states continue to make regressive tax changes that benefit the wealthiest taxpayers, he said.

“The real risk for states is that they’re being a bit penny wise, pound foolish by thinking that they can afford a tax cut in the short term because of those surpluses, because of reasonably strong revenue growth of late,” he said. “But as collections decline, as the cost of the tax cuts grow, states are really going to be potentially pinched over the next five to 10 years.”

State Budgets Are Strong (for Now)

Over the past two years, state spending has ballooned.

A survey from the National Association of State Budget Officers shows state general fund spending increased 12.6% in fiscal year 2023, totaling $1.2 trillion. That was after a 16.8% increase in fiscal year 2022.

Nearly every state saw its tax revenues exceed official estimates over the past two years. And cumulatively, states more than doubled the amount saved in their rainy-day funds since 2019, reaching more than $160 billion in fiscal year 2022, according to the association.

“I’d say overall states remain in a strong fiscal condition,” said Brian Sigritz, director of state fiscal studies at the association.

But state revenues already have begun to fall in some states, including Iowa, Kentucky and Mississippi—which all cut taxes in recent years. The association’s spring survey found state revenues have begun to decrease slightly—a trend expected to continue through the fiscal year because of tax cuts, slower economic growth and weaker stock market performance.

“We received record growth there for two years in a row and so now it’s lower growth off that high baseline,” Sigritz said. “In some ways, we’re returning to a normal pattern.”

Huge surpluses over the past few years essentially forced states to decide between major spending projects and tax cuts.

“It’s politically untenable to hold this amount of cash and not do something with it,” said William Glasgall, senior director of public finance at the Volcker Alliance, a nonprofit that works to support public sector workers.

While states have stockpiled billions in reserves, the threat of an economic downturn still looms. After decades of underfunding public pensions, states, cities and other agencies owe more than $1 trillion, Glasgall said, and many states still have numerous deferred maintenance needs.

This month, the federal government said Americans must resume student loan payments after a three-year pandemic pause, leaving some 43 million consumers with less discretionary cash. The Pew Charitable Trusts, a nonprofit policy organization, warned the move could ultimately harm state revenues if borrowers trim their other spending—a particularly troublesome prospect for states that rely heavily on sales taxes.

And states have largely spent or allocated the nearly $200 billion Congress handed out in pandemic relief funds, Glasgall said. Those funds must be spent by the end of 2026. The Volcker Alliance has warned of the potential for a “fiscal cliff” for states that used the one-time funds for recurring costs.

“The big sugar high from all the money that went into the economy during COVID is running down,” Glasgall said.

Helping Specific Groups

In August, Kentucky’s budget director informed lawmakers that tax revenues weren’t strong enough to meet a fiscal requirement set by the GOP-controlled legislature that would have allowed legislators to continue cutting income taxes.

The left-leaning research group Kentucky Center for Economic Policy framed the news as a “glimpse of future trouble” for the state, particularly since low unemployment and high inflation continue to push up incomes.

But State Senate Appropriations and Revenue Chair Chris McDaniel said including the so-called revenue triggers shows the state is cutting taxes responsibly. He said it’s a stark difference from the failed tax experiment in Kansas, where then-Gov. Sam Brownback, a Republican, led an effort in 2012 to dramatically slash income taxes in the hopes of spurring an economic boom, but instead was forced to cut education, infrastructure and other spending as revenues tanked.

“That will forever inform the way I think my generation of political leaders looks at the tax issue,” McDaniel said. “I would rather take 10 years to get the reform right than to promise people things I have to walk back in two years.”

The Kentucky General Assembly cut the personal income tax rate from 5% to 4.5% in 2022. Missing this year’s trigger means that rate won’t be going down next session. But McDaniel said he would still like to see the state realize a longtime GOP goal of eliminating the state income tax.

Aside from personal and corporate income taxes, states have made changes aimed at helping specific groups, including older adults, homeowners and families.

This year, 18 states implemented or changed earned income tax credits or child tax credits, said Aidan Davis, the state policy director at the Institute on Taxation and Economic Policy.

“Those really are policies that are going to make a real difference in the economic security of millions of families,” she said. “So that was a really prominent trend this year.”

But many states took what Davis characterized as “steps backward” by making deep, permanent cuts that will not only hold down state revenue for years to come, but mostly benefit upper income residents.

That was the case with a recently approved change in Missouri that eliminated state income taxes on Social Security benefits, said Democratic state Rep. Deb Lavender.

The legislation, expected to cost Missouri more than $300 million per year, removed a previous income cap of $85,000 for single filers on pension benefits. That means high-earning individuals will benefit the most, Lavender said.

“We talked about our poor seniors,” she said. “This didn’t help a single one of those people that has to decide if they’re buying food or paying rent or getting medicine.”

The legislation was sponsored by Republican state Sen. Tony Luetkemeyer, who said retirees on fixed incomes shouldn’t see their Social Security benefits taxed. The new law, he said in January, “keeps seniors from having to hand over more money to government.”

That legislation came a year after nearly $800 million in tax cuts in 2022. The GOP-controlled legislature hoped to pass a $1 billion reduction in corporate and personal income taxes this year, but was unable to because of ongoing dysfunction in the state Senate.

Lavender said the state has plenty of needs those revenues could address.

Missouri is home to rising maternal mortality rates. And starting teachers in Missouri earn on average the lowest salary of educators in any state.

“I’m not an advocate for increasing taxes,” she said. “But could we just stop cutting?”