More states have been lowering or eliminating income taxes in order to spur economic growth in recent years. In 2013 alone, eight states lowered some aspect of their income tax rates, and several others are considering similar changes this year. Historically, income tax cuts have led to greater economic development and tax revenue for the government, the Tax Foundation notes.
The short-term revenue results of these income tax cuts have been mixed, and opponents of tax cuts have used these shortfalls to discredit them. However, state income tax collections have decreased in most states in recent years, including many that did not lower income taxes. A recent study by the Rockefeller Institute of Government found state personal income tax collections declined by 7.1 percent from January to April 2014 compared to the same months a year earlier for 38 early reporting states. Out of 38 states that impose broad-based personal income taxes, 33 had declines, with 10 states reporting double-digit decreases, the study found.
The drop in revenue varied widely between states. According to The Washington Post, Iowa suffered a decrease of 4.1 percent, and Mississippi and South Carolina both had decreases of 3.7 percent. California and Maine had sharp drops: 11.1 percent and 15.3 percent, respectively. Maryland was one of the few states to experience an increase, posting a 1.5 percent rise in personal income tax collections and a 10.4 percent increase in corporate income tax revenue.
Supporters of income tax cuts argue these revenue shortfalls were to be expected, as the increased revenues received in 2013 were based not on any widespread economic improvement but on taxpayers’ reaction to the potential for large tax increases once tax cuts put in place by George W. Bush expired. At the end of 2012, in anticipation of the tax cuts expiring, many investors, businesses, and high-income earners cashed in capital gains or sold stock to get in under the lower tax rates. This shift created a tax windfall in many states. According to The Washington Post, personal income tax revenue rose 18 percent and corporate income taxes increased by about 10 percent.
This one-time windfall in April 2013 is now being counterbalanced in April 2014, with states collecting $7.9 billion less than in the same month in 2013. The Rockefeller Institute study notes many states attempted to take this distortion into account when they made their 2014 revenue forecasts, but many were unable to predict how sharp the decrease would be: “Declines in personal income tax collections were much anticipated but the size of the declines surprised officials in many states. It was extremely difficult for states to forecast personal income tax collections as it was hard to sort out the impact of income acceleration from tax year 2013 to tax year 2012 relative to the countervailing effect of the strong 2013 stock market.”
A state’s tax policy should focus on bringing in enough revenue to cover the costs of necessary functions of government in the least economically distorting way possible. Personal and corporate income taxes are generally considered to be the most destructive taxes because they disincentivize production, innovation, and risk-taking. Recent studies have shown states with no income tax or with lower income taxes perform better economically and achieve greater job and population growth than those with higher income taxes. State lawmakers should consider income tax reforms that encourage these behaviors to help promote economic growth.
The following articles examine income tax reform from multiple perspectives.
April “Surprises” More Surprising Than Expected: Depressed Income Tax Collections Adding to Budget Pressures
States that collect personal income taxes enjoyed strong growth in income tax collections last year but face widespread shortfalls this year, according to this report from the Rockefeller Institute of Government. The report examined tax collections from January to April 2014 for 38 of the 41 states that impose broad-based personal income taxes. It displayed an overall decline of 7.1 percent, or $8.4 billion, when compared to the same period a year earlier.
States Blame Fiscal Cliff for Tax Revenue Slide
Reid Wilson of The Washington Post notes tax revenues have dropped in numerous states for the first time since the end of the recession, and many states are attributing this decrease to lingering effects from the fiscal cliff negotiations at the end of 2012.
Revenue Shortfalls and Debt Downgrades in Kansas
Will Freeland of the American Legislative Exchange Council examines two recent tax-related developments in Kansas: a state bond downgrade by Moody’s and lower than expected income tax revenues. Although opponents of Kansas tax reform and reform efforts outside the state are hailing this as a “teachable moment” on problems with tax reform, Freeland argues they misunderstand the source of these problems and the virtues of tax reform in putting the state on firmer fiscal footing. Lower than expected tax returns are largely the result of the slow economy and federal tax policy, he argues.
Surpluses and Tax Cuts for Some States, Deficits for Others
Pamela M. Prah of Stateline discusses how states have emerged from the recent recession and how their budgets and employment figures have worsened or improved: “For the first time since the recession ended, state revenues and employment have both surpassed pre-recession levels, at least in the country as a whole. But if this is finally the ‘good times,’ it sure doesn’t feel like it to some states.”
Ten Principles of State Fiscal Policy
The Heartland Institute provides policymakers and civic and business leaders a highly condensed, easy-to-read guide to state fiscal policy principles. The principles range from “Above all else: Keep taxes low” to “Protect state employees from politics.”
States See Spring “Surge” in Income Tax Revenues
Joseph Henchman of the Tax Foundation examines the 2013 tax windfall that emerged due to the 2012 fiscal cliff. Henchman warns states against assuming the additional revenue was anything but a temporary increase: “All good news, right? So long as we understand that if [acceleration of capital gains realizations] is indeed the cause, much of the boost is temporary. One-time sales of capital gains are exactly that: one-time. The CBO report I just linked to unnerved me a bit because they show this spring’s tax revenues as an upward trend rather than a spike. States should be careful not to make that same assumption.”
CBO Disproves Paul Davis’s Talking Points on Kansas Revenue Numbers
Will Upton of Americans for Tax Reform responds to critics of Kansas tax reforms who point to the decreases in revenue as proof of a failure of income tax cuts: “A quick glance at the CBO’s Monthly Budget Review would have provided some clarity for Davis and Hutchinson News. For instance, the January 2013 report notes: ‘Nonwithheld tax receipts for the first four months of the fiscal year rose by $15 billion (or 18 percent), mostly owing to the January boost brought about by taxpayers’ shifting of income from calendar year 2013 into late 2012 in anticipation of higher tax rates.'”
1920s Income Tax Cuts Sparked Economic Growth and Raised Federal Revenues
Veronique de Rugy, a fiscal policy analyst with the Cato Institute, compares the federal government’s income tax cuts of the 1920s to recent income tax cut proposals. De Rugy finds the 1920s cuts brought an initial decline in revenue followed by increased revenue as the economy improved. “The tax cuts of the 1920s were the first federal experiment with supply-side income tax rate cuts. Data for the period show an initial decline in federal revenues as tax rates were cut, but revenues grew strongly during the subsequent economic expansion. After the cuts, total tax payments and the share of total taxes paid by the top income earners soared,” she writes.
Census Data Shows Tax Revenue Recovery following Recession
Tyler Dennis, Scott Drenkard, and Liz Emanuel use federal census data to determine changes in state tax revenue since the end of the recession. They find tax revenue has recovered. “Despite claims of state revenue shortages since the recession, steadily increasing revenues have nearly pushed total state collections back to pre-recession levels. After adjusting for inflation, the difference between collections at the peak of the bubble and current collections is only about 2 percent,” they write.
The Historical Lessons of Lower Tax Rates
Daniel Mitchell of The Heritage Foundation examines the historical results of income tax cuts and finds a distinct pattern throughout American history: When tax rates are reduced, the economy’s economic growth rate improves and living standards increase.
Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the Budget & Tax News Web site at https://heartland.org/publications-resources/newsletters/budget-tax-news, The Heartland Institute’s Web site at http://heartland.org, and PolicyBot, Heartland’s free online research database, at www.policybot.org.
Whether sending an expert to your state to testify or brief your caucus, hosting an event in your state, or simply sending you further information on a topic, Heartland can assist you. If you have any questions or comments, contact Heartland Institute State Government Relations Manager Logan Pike at [email protected] or 312/377-4000.