Last year, states facing economic shutdowns projected staggering budget deficits and appealed to Washington for financial help. They got it in the form of hundreds of billions of dollars from the American Rescue Plan. But tax revenues have bounced back faster than expected, and the fiscal nightmare that officials dreaded never arrived. At least 11 states, all Republican-leaning, have responded recently by cutting personal and (in some cases) corporate tax rates, with others contemplating cuts next budget cycle. By contrast, a few blue states are looking to take even more revenue from taxpayers.
These moves suggest that America might be heading into a new cycle of regional competition over tax policy.
In 2020, fiscal analysts predicted that states would lose an astounding $150 billion in revenue in 2021. The National Governors Association asked then-president Donald Trump for $500 billion in aid—equal to half the revenue states had collected in 2019. Trump handed over federal money in the form of aid for Covid-related costs, but Republicans in Washington balked at direct budgetary help for states.
President Joe Biden saw things differently. Earlier this year, the Biden administration stepped in with $350 billion of largely unrestricted aid for states and municipalities. These states have gotten the money even though the feared fiscal tsunami never materialized. Instead of a projected $40 billion deficit, California enjoys a $75 billion surplus. Minnesota’s more modest budget went from a projected $1.3 billion deficit to a $1.6 billion surplus. Colorado’s extra cash totals $5 billion; Michigan’s, $2 billion. Some states and their municipalities have responded to this bounty with ambitious, though often untested, plans to do everything from tackling generational poverty to wiring statewide with low-cost broadband to retooling their economies.
But others are giving some of the money back to taxpayers. In Arizona, tax revenues grew by a robust 21 percent last year instead of declining, the Tax Foundation estimates. So the state has enacted a $1.9 billion tax cut that, among other things, caps the top income tax rate at 4.5 percent. That’s partially meant to restrain the growth of tax rates after a ballot initiative—heavily promoted by public-sector unions—to institute a surcharge on high-income residents passed last November. Without the recently passed tax cuts, the ballot initiative would have raised Arizona’s top income tax rate to a whopping 8 percent. Now, even with the surcharge, the rate will stay the same, while the rates other state residents pay will decline.
The states cutting taxes lean toward the GOP. Idaho’s treasury was even more flush with cash—tax revenues grew 35 percent in fiscal 2021—so the state cut income and corporate taxes a combined $163 million. Nebraska cut its top corporate tax rate, Iowa accelerated tax cuts that had been passed in 2018 but hadn’t yet taken effect, and Montana is reducing its top tax rate. Wisconsin, Oklahoma, Iowa, Missouri, Louisiana, Ohio, and New Hampshire are all joining the party with cuts of their own. All have Republican-majority legislatures (except for Nebraska, which has a unique nonpartisan body) and all except two have Republican governors.
Some Democratic-led states, by contrast, have other ideas. New York State received $12.5 billion from the Biden stimulus but nonetheless raised taxes on wealthy residents and corporations by $4.3 billion—a move that one business leader described as “a political statement aimed at punishing the rich—not a reflection of economic need.” The legislature originally had targeted up to $7 billion in new taxes, but ultimately “compromised” by imposing fewer increases. Massachusetts Democrats are up to something similar: not content with $8 billion in Biden dollars, they recently voted to place an initiative on the state’s ballot to amend the state constitution so that they can pass a $2 billion tax hike. Illinois governor Jay Pritzker also wanted to increase income taxes on the wealthy, but the state’s constitution prohibits charging higher tax rates for some citizens. Pritzker tried to get Illinoisans to amend the constitution so that he could do it, but they voted down his proposal last November.
California and its $75 billion surplus occupy a category of their own. Governor Gavin Newsom, facing a recall election in September, voted to give some of that money back to residents, but not in the form of permanent tax cuts. Instead, every resident with an income of $75,000 or less is getting a one-time payment of $600. Earlier this year, the state also handed out $600 checks to low-income residents, including immigrants who didn’t qualify for federal stimulus checks sent to individuals. Not surprisingly, the latest checks are scheduled to arrive before September’s recall vote.
It’s unlikely that we’ve seen the last of these moves. In the wake of Barack Obama’s election in 2008, emboldened Democratic-led states enacted a series of tax increases. Obama followed with his own federal tax boost in 2013. Republican governors responded with a barrage of tax cuts, then pitched their lower rates to residents and businesses in higher-taxed blue states.
Now Biden is angling for his own federal tax increases on individuals and businesses. He already tried to forestall Republican state cuts by decreeing that stimulus funds couldn’t be used to reduce taxes. States fought back, suing the federal government for the right to reduce taxes, and cuts followed as states sought to gain a competitive edge. Arizona Republicans pointedly cut the taxes of wealthy residents to maintain a competitive edge over California and New York, which have been losing wealthy residents to the Grand Canyon State, among others. More cuts will come as the tax policies of red and blue states continue to diverge.