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The Trump Effect on State Taxes

eye on the news

The Trump Effect on State Taxes

Some governors want to return the windfall from the federal reform to residents. February 27, 2018
Economy, finance, and budgets
Politics and law

Ever since President Trump signed tax reform in late December, lowering corporate and personal income-tax rates, attention has centered on the efforts of legislators in high-tax places like New York and California to find a way around the new federal provisions. Facing a cap on the ability of taxpayers to deduct their state and local taxes, New York governor Andrew Cuomo has proposed creating charitable trust funds to which taxpayers could donate for education and health-care services, in exchange for state tax credits. California’s state senate has already passed a law permitting similar contributions, though the savings will depend on whether the Internal Revenue Service allows these payments to qualify as charitable donations.

But the real news may turn out to be the way other states are looking to reform their own taxes in order to return to residents any windfall—and more—that state governments gain from the impact of federal tax reform. At least 17 states estimate that taxpayers would have to pay more in state levies as their residents’ federal taxes go down, increasing their taxable income. In Georgia, South Carolina, Iowa, and Maine, officials have already begun revamping their tax codes to ensure that federal tax reform doesn’t result in higher state taxes. “That’s the right thing to do,” Maine governor Paul LePage said in his recent State of the State address.

Without changes, many states will see a boost in their own tax revenues because of how local tax codes are pegged to the federal code. Nebraska tax law, for instance, contains a personal exemption tied to the federal income tax. Residents can claim a credit for each household member on their state taxes, for a savings of $536 for a family of four. But federal reform eliminated the personal exemption and instead nearly doubled the standard family deduction to $24,000. While Nebraskans will pay less in federal taxes, their state bill will increase by $220 million. The dynamic is similar in other states. South Carolina officials estimate that residents will see approximately $1.6 billion in federal tax savings, but without changes to the state’s tax code, they’d also have to pay about $200 million more in local taxes. Iowans will net $1.5 billion from federal tax reform but could pay as much as $138 million in additional state levies.

Not everyone wants to give the windfall back to taxpayers. In an opinion piece, Nebraska governor Pete Ricketts observed that some states’ legislators “want to take this money and spend it.” Instead, he’s proposed legislation that would restore Nebraska’s personal exemption even as the tax credit disappears at the federal level, preserving that $536 savings for a family of four. Georgia has gone one step further. The state anticipates one of the biggest bonanzas from federal tax reform: more than $1 billion a year in additional state taxes. But Georgia will give back that money, and an extra $100 million a year over the next five years, by cutting the state’s top income-tax rate from 6 percent to 5.5 percent and doubling the standard deduction to $6,000.

New Iowa governor Kim Reynolds, who succeeded incumbent Terry Branstad when he became ambassador to China, is similarly going big. Iowa is one of three states that allows residents to deduct their federal tax liability from their state taxes; so as federal taxes fall, Iowans will face higher state taxes. Reynolds is proposing to give that money back, and more. She’s promoting a tax cut that would total about $1.7 billion over five years. It would slash personal income-tax rates by as much as 23 percent, eliminate the state’s alternative-minimum tax, and apply new federal deductions for businesses to the state level.

Some states seem inspired by the brashness of the federal reform package. Missouri governor Eric Greitens has proposed a tax overhaul that would lower the individual rate for most state residents to 5.3 percent from 5.9 percent and cut the corporate rate to 4.25 percent. To offset some of the loss of revenues, the plan phases out some individual deductions for federal taxes and eliminates some business-tax credits. Sounding like President Trump, Greitens calls his plans the “boldest” reform in the nation. Whether he can effectively lobby for it in the wake of the personal scandal plaguing his governorship may determine if Missourians get that big tax overhaul.

New York State would likely receive the largest windfall, estimated at $1.5 billion a year. Under current law, New York allows taxpayers to itemize their deductions if they also do so on their federal forms. But far fewer taxpayers are likely to itemize under the new federal law, and those New Yorkers who don’t would lose their state deductions. New York officials don’t want to see that happen, given how much they have complained about their citizens losing their federal SALT deduction. So Governor Cuomo has proposed adjusting the tax code to allow citizens to retain their state deductions. It hasn’t made headlines in New York, though, because the press has been obsessed by Cuomo’s efforts to find loopholes in the federal law to preserve the SALT deduction. That effort is likely to be far less effective at saving the state’s taxpayers money than simply adjusting to the new reality in Washington.

Whatever the individual circumstances, one thing is clear: radical federal tax reform is helping create the most vigorous state budget season in years.

Photo: mediaphotos/iStock

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