Bush Tax Cut Hits States’ Wallets

At a time when the slowing national economy is already threatening the states’ financial health, the package of tax cuts passed by Congress figures to compound their fiscal woes.

Billed by the Bush administration as tax relief for all people, the tax cuts will drain billions of dollars from state coffers as the states’ share of the estate tax is phased-out and income taxes are lowered, experts say.

Even President George W. Bush’s brother, Florida Gov. Jeb Bush, says the cuts will make balancing Florida’s books more difficult. The estate tax cut alone will cost Florida $174.3 million in 2003, and hundreds of millions more in years to come. The loss of this money has Florida lawmakers rethinking their own tax cuts. Nevertheless, Gov. Bush supports his brother’s plan.

“Some people might call it a hit, but I call it tax relief,” the St. Petersburg Times reported Gov. Bush as saying. “It would be a little hypocritical to say, ‘Well, woe is the state of Florida,’ because I think the death tax is a horrible tax. I’m happy Congress eliminated it. We were disappointed they didn’t phase it out over 10 years. We’ll live with it.”

No one is sure of the tax cut package’s total impact across all the states. Differing tax structures from state to state and the unpredictability of the economy’s performance over the next decade make such calculations notoriously unreliable. But even though the exact numbers are not certain, says Frank Shafroth of the National Governor’s Association, the tax plan is sure to be “one of the single largest revenue hits to the states ever.”

This comes at a time when many states are struggling to balance their budgets. A decade of tax cuts and a recently slowing national economy have forced many states to weigh cutting programs against dipping into rainy day or tobacco funds. “Governors are already making tough decisions and this will make things a little more difficult for them,” says Ken Powers, spokesperson for the NGA.

The most significant policy change for states is the phase-out of the federal estate tax, dubbed “The Death Tax” by critics. All the states have received a portion of this tax since 1926. Today, it accounts for roughly 1.1 percent of total state tax collections. The NGA estimates its elimination will cost states $69 billion over the next ten years. Some fifteen states also levy their own estate or inheritance taxes.The federal estate tax’s phase-out will come in stages, with the federal government receiving a diminishing amount of revenue through 2011. But the states’ share of that revenue will decrease at an accelerated rate–it will be cut in half in 2003 and eliminated in 2005.

This wrinkle precipitated a last minute lobbying effort by 38 governors to keep the states’ share of the estate tax consistent through 2010. In a letter to congressional leaders, the governors wrote, “Regardless of one’s view about phasing out the federal estate tax, the governors are absolutely united in opposing any action that would discriminate against states in the phase-out of the state and federal estate taxes. . .The changes proposed by the Senate would have abrupt, significant adverse impacts on state revenues at a particularly onerous time for many states.”

The governors’ effort felt short, but they did manage to cushion the blow somewhat. The planned 50 percent reduction in 2002 was eased by Congress to 25 percent. The 50 percent reduction won’t kick-in until the following year, 2003. In 2004, the states’ share will be reduced by 75 percent. Full elimination will follow in 2005.

States with the largest concentrations of wealth, such as California, Illinois, New York and Texas, figure to be hit hardest. Last year, California alone took in $937 million from the federal estate tax credit, while Florida raised $779 million, the second highest figure among the states. The total for all the states was $5.5 billion, according to the Center on Budget and Policy Priorities. The loss of this revenue has budget directors scrounging for dollars.

Nevada is one small state that will take a big hit. Last year, it collected $76.7 million from federal estate tax revenue. This amount pales in comparison to the totals from California and Florida. But because Nevada’s total budget is also much smaller, its loss from the estate tax phase-out will be equal to almost 5 percent of its budget.

Analysts say the income tax cuts of the Bush plan will be a boon for some states and a bust for others.

More dollars should flow into the coffers of the nine states that allow taxpayers to deduct federal income taxes from state taxes. Lower federal tax liability will mean smaller deductions at the state level. Oregon, for example, expects to net $20 million over the next few years from smaller deductions for federal taxes paid.

But the consequences are much less sunny for the eight or nine states whose income taxes are linked to federal income taxes. This is especially so for Rhode Island and Vermont, who base their income tax calculations on federal tax liability.

Vermont expects to see a $21 million loss in fiscal year 2002, or 2.5 percent of the state’s budget, according to Susan Allen, spokesperson for Gov. Howard Dean. Legislators are weighing various options to recoup these dollars. Proposals include de-coupling the state income tax from federal liability or raising the state’s rate from 24 to 25 or 26 percent of federal tax liability.

Allen says Gov. Dean had opposed Bush’s tax plan primarily because he thought it would have deleterious effects on the budgets of his and other states.