Is state tax reform coming in waves?
Contending with several quarters of weak growth in overall state tax collections, between 25 and 40 states are facing revenue shortfalls. The budget season is heating up with a flurry of legislation proposed to close those budget gaps for the 2018 fiscal year. Many of the proposals include sales tax base expansion, nexus expansion, new and higher “sin taxes” (taxes on cigarettes and alcohol), fuel tax increases, and even new Ohio CAT-style gross receipts tax proposals. At heart, among the states the key driver in all of these proposals has been budget deficits, and not the murky prospects of near-term federal comprehensive tax reform. However, recent events suggest that is about to change.
Anyone that closely follows federal tax reform has learned to be patient – this is going to be a long and involved process in Congress, likely without a draft bill until later in 2017. The reform proposals from the President and the GOP-controlled House are similar but still have significant differences. Almost all the proposals would have an impact on state revenues. For example, an increase of the standard deduction or a repeal of the federal estate tax could negatively impact state revenues in states that are coupled to the federal provisions or that rely on federal estate tax audits, respectively. Alternatively, an increase to the federal tax base and a limitation of deductions may result in state tax revenue increases.
With all these moving parts and uncertainties at the federal level, the states have learned to be patient too, and are focusing their legislative energy on revenue raisers independent of the federal tax system. Right? Well, maybe not.
Recently, one of the first affirmative signs that states are thinking preemptively about federal reform came out of Oklahoma. On May 12, 2017, Oklahoma Gov. Mary Fallin signed House Bill 2348, freezing the standard deductions currently coupled to the federal standard deductions. While this state-level change will increase revenue in the short term (the federal deduction is increased for inflation, whereas the new Oklahoma provision is not), the intent behind the legislation appears targeted at the federal reform proposals which have essentially called for doubling the standard deduction – a measure certain to decrease state revenue. Why address this issue now? The simple answer…states might not have time to address it later.
Gone are the days where tax reform was to be addressed in the “first 100 days,” and, instead, the enactment of federal reform is likely to wait until the end of the year with retroactivity to the beginning of 2017. This federal legislative calendar does not leave the states any time to respond, which means they will have to cover both their own budget crises and the potential impact guessed-at federal tax reform now, and then address both issues again after federal tax reform is enacted. This two-wave approach at the state-level means that taxpayers will have to be prepared to address significant state tax changes in the near-term and then again after once federal tax reform runs its course.
Bookmark our tax reform resource center for continuing coverage as the process unfolds.