State Revenues Hit By Bush Tax Bill

Despite doling out $20 billion in fiscal aid to state governments, President Bush’s $350 billion tax cut bill will drive down total state tax collections by at least $1 billion and as much as $3 billion over the next two years, dampening the bill’s positive impact on state coffers, analysts say.

That’s because nearly every state piggybacks portions of its tax code on the federal code to ease the tax-filing burden on individuals and businesses. As a result, the package of tax cuts Bush signed May 28 will force corresponding tax cuts in many states, barring state action to decouple from the federal tax code.

Viewed in the context of total state general fund spending, which exceeds $500 billion a year, the billion dollar-plus revenue loss from the federal tax bill is not huge. But with many states facing the tightest budgets they’ve seen in a generation and lawmakers balancing teacher layoffs against cutting road construction against raising taxes, some state officials would have preferred to avoid even this small loss.

“The federal government made tax cuts that because we’re tied to the federal tax system actually hurt us. . . . Clearly, any kind of tax cut proposals not hurting us more is a key thing,” Kansas Budget Director Duane Goossen told Stateline.org.

Goossen predicts Kansas will lose between $10 million and $16 million in fiscal year 2004 and between $8 million and $13 million in fiscal year 2005.

Despite the revenue loss, the tax bill is far from a total bust for Kansas. In fact, the package as a whole is a net gain, because it contains more than $150 million in direct aid for the state. The same goes for most other states, with the bill’s estimated $1 to $3 billion in negative state tax effects offset by $20 billion in direct aid.

The Bush tax cuts’ impact on the economy will also affect state coffers. The White House predicts the tax cuts will spur the creation of 1.4 million jobs over the next 18 months. Many economists predict lower numbers.

Idaho Gov. Dirk Kempthorne (R) hopes the federal tax cuts will ease the pressure on his state’s budget by kick-starting economic activity.

“The most important thing that Congress and the President can do to help the states is to work together to jump-start our economy. The President’s economic stimulus plan is exactly what we need,” Kempthorne said in a recent speech at Harvard University.

The direct hit to state coffers could have been much worse had Bush’s original proposal been passed untouched by Congress. Analysts say that bill would have cost states more than $10 billion over the next two years. Also, Bush’s original proposal contained no direct aid for states.

“[I]t’s not nearly as bad as it could have been for states. The states would have got walloped [by Bush’s proposal],” said David Brunori, contributing editor for State Tax Notes and research professor of public policy at George Washington University.

The tax change that will most depress state taxes is a provision called “bonus depreciation,” which allows businesses to deduct the cost of equipment purchases from their income. Normally, the deduction for capital expenses must be spread over the useful life of the equipment.

But under the new tax law, businesses can deduct up to 50 percent of the cost of new equipment in the purchase year. Congress approved a similar provision in 2002, allowing businesses to deduct up to 30 percent of new equipment costs in the first year.

At that time, many of the states with corporate income taxes broke their ties to the federal tax code to preserve the revenue flow. Analysts say some of the remaining 13 states affected by the bonus depreciation measure in the new tax bill can be expected to explore a similarly remedy. Four other states that only partially decoupled also may revisit the issue.

“I suspect you’re going to see more decoupling, although politically it’s very dangerous, it’s very difficult to do,” Brunori said.

States potentially affected by the bonus depreciation provision include: Alabama, Colorado, Delaware, Florida, Kansas, Louisiana, Montana, Missouri, New Mexico, North Carolina, North Dakota, Oklahoma, Oregon, South Dakota, Utah, Vermont and West Virginia.

Business groups and fiscal conservatives fight hard against decoupling, arguing that it counteracts the stimulative effects of federal tax cuts. They also say that decoupling forces businesses to keep two sets of books one for state government; one for the federal government an expensive prospect.

“[Decoupling] really complicates the system. You have to figure out your taxes for federal taxes and then do them again for state purposes. The more conformity there is the less administrative costs and hassles both for the government and for the taxpayer,” Brunori said.

However, none of the arguments against decoupling may be strong enough to compel cash-strapped states to keep their tax codes aligned with the federal code. “But at the same time, the bottom line is, states need the money,” Brunori said.

Besides bonus depreciation, two other federal tax changes will hit state coffers, according to the Center on Budget and Policy Priorities (CBPP), a left-leaning think tank in Washington, D.C.:

An increase in the federal income tax deduction for married couples will depress revenues in the ten states that conform to the federal standard deduction. CBPP estimates the total loss at roughly $245 million over the next two fiscal years in the following states: Maine, Minnesota, Missouri, Nebraska, New Mexico, North Dakota, Rhode Island, South Carolina, Utah and Vermont.

An increase in the tax break small and medium-sized businesses receive for equipment purchases will drive down taxes in the forty-four states that conform to this federal provision. CBPP estimates that these states will share total revenue losses of $600 million in fiscal year 2004 and $500 million in fiscal year 2005.