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A Review of Significant State Tax Changes During 2009

Written by Joseph Henchman

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Tax Foundation

Introduction

During most of this decade, state lawmakers responded to surging tax revenue by boosting state spending growth to an unsustainable level. Now that boom has turned to bust, significant structural budget deficits have opened up in many states. Throughout 2009, state officials struggled to close these gaps. They face three choices to meet their budgetary obligations.

One option is to raise taxes. Officials generally claim that the budget cannot or should not be cut any further, and that the benefits of tax increases for the state budget outweigh the economic damage they can do in an economic downturn. Most states taking this option aimed their taxes at specific groups such as high-income earners, smokers, or out-of-state business transactions. These revenue sources may provide short-term relief but can cause substantial economic harm to the state economy in the medium and long term.

The opposite approach is the second option: roll back spending growth commitments made during previous years and take actions to spend no more than the state brings in. Arkansas and Indiana have taken this path.

The final and politically easiest option is to use one-time funds and accounting gimmicks to paper over the current state budget shortfall, but without significantly curtailing spending. This irresponsible approach amounts to praying that the economy will soon recover and bring a surge of tax revenue. California has taken this path for several years in addition to raising already-high taxes, building up to a crisis in 2009 when the state issued IOUs, borrowed, seized funds from local governments, and enacted requirements that companies increase withholding to 110% of what workers owed-in essence an interest-free loan to the state.

Other factors in these decisions have been the draw down of rainy day funds by most states (Texas notably has several billion dollars remaining), the availability of one-time stimulus aid but with strings that forbid cuts to huge swaths of state budgets, and increasing abuse of state Medicaid matching funds as a way to shift state general spending to the federal taxpayer.

For more information on each state's tax system, see the Tax Foundation State Tax Information website at .

State Changes to Individual Income Taxes

Increases

o For more information, see Tax Foundation Fiscal Fact, No. 170, "A Golden Opportunity: California's Budget Crisis Offers a Chance to Fix a Broken Tax System," (5/18/09).

o For more information, see the Tax Foundation report, "Connecticut Tax Hikes in Proposed Budget," (8/27/09).

o For more information, see Tax Foundation Fiscal Fact, No. 169, "The Price of Paradise: Hawaii Becomes Fifth State to Adopt New Income Tax Brackets on High-Earners," (5/12/09).

o For more information, see Tax Foundation Fiscal Fact, No. 171, "New Jersey's Governor Corzine Proposes 10.75% Income Tax Rate," (5/27/09).

o For more information, see Tax Foundation Fiscal Fact, No. 159, "New York Governor Paterson's Tax and Fee Proposals a Mixed Bag," (1/22/09).

o For more information, see the Tax Foundation report, "North Carolina Reportedly Reaches Budget Deal," (8/3/09).

o For more information, see Tax Foundation Fiscal Fact, No. 175, "The Dam Bursts in the Beaver State: Oregon's Wave of Tax Increases and New Spending," (7/9/09), and the Tax Foundation report, "Oregon Sets Referendum on Highest State Income Tax," (12/18/09).

Reductions

o For more information, see the Tax Foundation report, "Louisiana Governor Jindal Stands By Tax Cuts and Tax Credits; Holds Off Using Rainy Day Fund," (12/29/08).

o For more information, see Tax Foundation Fiscal Fact, No. 174, "The Pine Tree State Chops Down Income Tax: Maine Enacts Major Tax Reform" (6/23/09).

o For more information, see the Tax Foundation report, "North Dakota Cuts Income Tax," (5/27/09).

oFor more information, see the Tax Foundation report, "Ohio Governor Picks Up Votes for Preventing Income Tax Cut," (12/2/09).

o For more information, see the Tax Foundation testimony, "Vermont Income Tax Proposals Would Enable Elimination of Sales Tax," (12/3/09).

State Changes to Sales Taxes

o For more information, see Tax Foundation Fiscal Fact, No. 170, "A Golden Opportunity: California's Budget Crisis Offers a Chance to Fix a Broken Tax System," (5/18/09).

o For more information, see the Tax Foundation report, "Connecticut Sales Tax Reduction Cancelled," (12/2/09).

o For more information, see the Tax Foundation report, "Flurry of Cross-Border Shopping After Massachusetts Raises Tax," (9/11/09).

o For more information, see the Tax Foundation report, "Nevada Governor to Veto Increase to Sales, Payroll, Hotel, and Car Taxes," (5/28/09) (the veto was subsequently overridden by the legislature).

o For more information, see the Tax Foundation report, "North Carolina Reportedly Reaches Budget Deal," (8/3/09).

o For more information, see the Tax Foundation report, "D.C. Approves Tax Hikes," (8/3/09).

State Changes to Cigarette Excise Taxes

Tax rates are per pack of 20 cigarettes. For a complete list of cigarette tax rates and for research on the topic, click here.

State Changes to Alcohol Excise Taxes (Beer, Wine, and Spirits)

For a complete list of alcohol tax rates, click here.

Miscellaneous

o For more on the District of Columbia tax, see the Tax Foundation report, "D.C. Charge on Plastic Bags is a Tax, Not a Fee," (11/17/09).

o For more on the Seattle tax, see the Tax Foundation reports, "Proposed Seattle Bag Tax Criticized," (6/30/08) and "No Bag Tax in Seattle," (8/19/09).

o For more on Amazon taxes, see the Tax Foundation report, "'Amazon' Tax: Unconstitutional and Unwise," (9/15/09).

o A forthcoming Tax Foundation report will examine the issue of obesity and soda taxes.

Lessons: Real Tax Reform Means Spending Restraint and Broad Tax Bases with Low Rates

With state revenues declining due to the tough economic situation, most state leaders in 2009 have tapped high-income earners, smokers, out-of-state business transactions, or other targeted groups, those being the only people that politicians feel safe raising taxes on. But the increases have come from a minority of states, and others should be cautious about enacting substantial tax increases on anyone in the midst of a recession.

High-income people have much more volatile income than middle-income wage-earners, largely because capital gains and business income are sensitive to changes in the economy and fluctuate rapidly.[1] Relying too heavily on these sources of income for tax revenue leads to unpredictability in tax revenues in the long run, with revenues surging in good economic times and plunging in bad. Increasing the progressivity of a state's tax system will exaggerate these effects, and states need to consider this when evaluating their fiscal situations.

When deciding in which state to live or locate their business, one of the factors that top earners must weigh is the marginal tax rate they will face in each state. While high statutory tax rates on high incomes may bring a revenue increase in the short term, they can harm long-term economic growth as providers of jobs and capital choose to locate in lower-tax states.

California has experienced these problems firsthand. Even before the recent tax increases, California had relied heavily on taxing capital gains and other income from high-income individuals. When the state experienced a huge revenue surge during the prosperous economic times in the middle of the decade, lawmakers responded by increasing spending levels to match those revenue surges.[2] Each year between 1999 and 2003, California general fund spending ranged between $71 billion and $75 billion. But encouraged by rapidly increasing revenues, spending reached $99 billion by 2007, a 31% increase over 2003. During the same period inflation increased 12% and the state population grew just 5%.

But decreasing spending is not nearly as easy as increasing spending, and when revenues fell California was left with a budget shortfall that has been estimated to be as high as $40 billion. Reluctant to cut spending but apparently wary of becoming any more reliant on volatile revenue from high-income earners, the legislature passed a broad-based income tax increase. Even with the tax increase and additional spending cuts, the shortfall still stands at tens of billions of dollars.

In addition to the volatility and spending issues, California's business environment has consistently ranked in the bottom five in the Tax Foundation's State Business Tax Climate Index.[3]

The lesson to be learned from California is twofold: states should not assume that revenue surges in good times will continue indefinitely, and the more reliant a state is on high-income earners the bigger hit they will sustain when those revenue surges eventually end. Therefore, legislators should adopt wise spending and tax policies that recognize and prepare their states for these economic realities.

Conclusion

When the recession ends, states need to have the right policies in place that will promote economic growth and maintain revenue stability. Relatively high taxes on high-income individuals, smokers, and out-of-state business transactions can make a state less attractive and create more volatility in an already uncertain economic climate.

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Joe Henchman is Tax Counsel and Director of State Projects, supervising the Tax Foundation's state policy and legal programs. He writes articles and reports on developments in tax policy and tax law, and provides analysis on tax issues to officials, activists, the media, and the general public. He also oversees the preparation of amicus curiae ("friend of the court") brief filings in select cases relating to federal and state constitutional and statutory law. His work has been featured in the New York Times, the Wall Street Journal, the Los Angeles Times, CNN, C-SPAN, Fortune, Barron's, State Tax Notes, and elsewhere.

 

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