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A new analysis from The Pew Charitable Trusts examines what cutting major deductions and other federal tax expenditures would mean for state governments.
If deductions and other tax expenditures were eliminated from the federal income tax code, dozens of states around the U.S. would be positioned to see revenues increase, according to an analysis The Pew Charitable Trusts published Wednesday.
Nationwide 40 states and the District of Columbia have broad-based personal income taxes, which incorporate various federal tax expenditures, including deductions, exclusions and credits. This means taxpayers in these places can claim these expenditures when filing state tax forms. The Pew analysis looks at what the effect on revenue might be in these states if the federal expenditures were repealed and states kept their codes aligned with U.S. tax law.
Researchers found that across the U.S. in 2013, if such a repeal had taken place, state individual income tax revenue would have been higher by about 34 percent, or roughly $100 billion. Revenues were higher in all 40 states that had income tax expenditure policies that mirrored federal law, and in the District of Columbia. But increases between the states were varied, ranging from 2.1 percent in New Jersey to 61.4 percent in Iowa.
“We know that states have a lot at stake in federal tax reform,” Anne Stauffer, who directs Pew’s Fiscal Federalism Initiative, said during a conference call with reporters.
Stauffer explained that larger increases in revenue indicated tighter conformity between tax expenditures granted under state law, and those at the federal level.
The theoretical scenario that was used for the Pew analysis involved eliminating 42 major personal income tax expenditures and repealing what is known as the alternative minimum tax, which is typically paid by higher income earners.
“It is important to note that this is not a tax reform proposal, it’s a scenario,” Stauffer said.
The scenario also included federal tax rates that were reduced by 40 percent across all tax brackets in order to keep revenue neutral. In other words, the lower rates would help offset the additional federal taxes people pay because they can no longer file for the deductions, exclusions and credits that would be cut. State tax rates were not reduced.
Pew’s report about the analysis points out that if a situation like the one in the scenario were to unfold, state policymakers would be confronted with a series of choices. To start, they’d need to decide whether to keep state tax expenditure policies linked to federal ones. If they maintain the connection, there would be questions about how to build fatter revenues into their state’s finances, possibly by increasing spending or cutting taxes.
A downside of decoupling state tax codes from federal law is that it makes filing more complicated for taxpayers, raising the chances of noncompliance and errors.
There is not a big tax reform package on the verge of passing Congress.
But proposals have been floated in recent years. A Congressional Research Service report from last July noted that a comprehensive tax reform package, known as the Tax Reform Act of 2014—sponsored by then-U.S. Rep. Dave Camp, a Republican from Michigan—continues to inform debate about the topic. That proposal would have modified or eliminated dozens of individual income tax credits, deductions, and other provisions, according to the report.
As the presidential primary contests play out, Democratic and Republican candidates have outlined a variety of federal tax reforms they’d like to see enacted.
While policymakers have made targeted revisions to the federal tax code in recent years, Pew’s Stauffer noted that the last major round of federal tax reforms was in 1986.