A new report issued by the Tax Foundation has found that the expiration of the Bush-era tax cuts would have effects on state taxes as well. Because many state tax systems are based upon the federal tax code, these changes could translate into changes in state taxes. According to the Tax Foundation, some states could see tax increases while others could see tax reductions if the Bush-era tax cuts expire.
Why States Could See Increased Tax Revenue if Bush Tax Cuts Expire
According to this study, the main reasons some states could see an increase in tax revenue if some or all of the Bush tax cuts expire are:
- Some state tax returns are linked to federal AGI. Expiration of the Bush-era tax cuts would cause federal AGI to grow, resulting in more taxable income at the state level.
- Some state tax returns that are linked to federal taxable income would be affected by reductions in federal itemized deductions. This would cause state taxable income to rise, thereby raising state tax revenue.
- Some state tax credits are based on federal credits: The Earned Income Credit and the Child Tax Credit were expanded during the Bush era and were further expanded by the Obama administration through the American Recovery and Reinvestment Act. If any of these expansions, or parts of these expansions, were allowed to expire, the amounts and eligibility for these federal credits would drop. Because some state child credits and earned income credits are based on federal amounts, state tax credits could also drop. This would lead to additional state tax revenue.
- Many state's base their estate taxes on the federal estate tax, so if the federal estate tax returns there could be an automatic return of the estate tax in many states. It should be noted that the federal estate tax of 2009 (prior to its expiration in 2010) only applied to estates valued at over $3.5 million.
Why States Could See Decreased Tax Revenue if Bush Tax Cuts Expire
The Tax Foundation’s report lists only a few ways that state tax revenue could decrease if the Bush-era tax cuts were to expire.
- Federal deductibility: some states allow taxpayers to deduct their federal taxes on their state income tax returns. If federal tax payments rise, state deductions will also go up, causing decreases in state tax revenue. See which states allow the deduction of federal income taxes.
- The Tax Foundation report proposes a theory that states that are highly dependent on sales taxes may lose revenue. The report asserts that this is because rising federal tax payments would leave consumers with less money to spend on products and services subject to sales taxes.
Why it May Not Matter
Although many states are linked in some way to the federal tax code, they are not required to do so. Most states depart from the federal tax code in one way or another, and other states have devised their own system entirely. If these tax cuts expire sometime in the future, and states do not wish to further burden their citizens with higher taxes they would not have to. The state would simply decouple from these new requirements. They could also set the date of their conformity to the federal tax code to a date prior to the expiration of these tax cuts.
In short, it’s all up to the states. There’s no requirement that they follow any new federal tax rule.
Also see: What is IRC Conformity? (how states conform to federal tax rules)
Source: Tax Foundation special report No. 187 “How Would Expiration of Bush-Era Tax Cuts Affect State and Local Budgets?”