States Cut Taxes Even As Washington Raises Them

Although federal taxes are rising for three-quarters of Americans this year, many states have spent the last two fiscal years cutting levies and simplifying their tax codes. Even as high profile battles to raise taxes in places like California have garnered the press's attention, from Kansas to Michigan to Oregon and New Jersey, states have actually been net tax cutters recently after trying for several years to tax their way out of budget woes.

In total, state legislatures over the last two fiscal years have cut taxes more than they increased them by a net of $4.3 billion, according to the National Conference of State Legislatures. Kansas Governor Sam Brownback has led the way with a budget that reduced the state's income tax rate to 4.9 percent from 6.45 percent, a cut of some $250 million, which will grow to $850 million in fiscal 2014.

The governor proposed the reductions as part of a reform package that also included capping some popular tax expenditures, including the mortgage interest deduction, but Republicans in the state's legislature balked at eliminating those items and passed a tax cut package without them. "The governor said early on ‘Go bold.' And we did," Kansas House Speaker Mike O'Neal told the press.

Brownback paid for the tax cut in part by keeping state spending flat and utilizing increased revenues from a modest upturn in the state's economy, but he'd still like to eliminate some tax expenditures to simplify the state's tax code.

Reform has been the theme of Michigan Gov. Rick Snyder's efforts to overhaul the state's tax code. The former business executive signed legislation that repeals the state's business tax and replaces it with a less onerous flat 6 percent tax on corporations. An estimated 90,000 small businesses in Michigan, so-called subchapter S corporations whose owners pay taxes on their firms' profits via their personal income tax returns, will be exempt from the business tax. Previously, many of these firms were double-taxed.

Snyder paid for the tax changes in part by eliminating some targeted business tax incentives and closing loopholes in the state's personal income tax code, including one that exempted public sector retirees from having to pay taxes on their pensions. Then, Snyder turned to the income tax, this time cutting the state's tax rate from 4.35 percent to 4.25 percent and increasing the exemption for each household member by $250, a tax cut of about $100 million.

Some tax cuts are the result of the expiration of temporary increases. In 2009 Oregon resident's voted for a two-year surcharge on income tax rates for those earning more than $125,000 a year, a move designed to alleviate state budget pressures. That tax rate expired and the legislature declined to extend it. The result is an estimated $133 million tax cut. "The people have voted, and they expect [the reduction to a lower rate] to happen. That's also the best thing to happen for the state right now," Oregon House Republican leader Kevin Cameron told the press.

One reason taxes are going down in the states is because of voter backlash after years of tax increases. States raised taxes every year from 2002 through 2010, including a whopping $28.6 billion net tax increase in 2009.

In New Jersey, for instance, Governor Jim McGreevey hiked taxes and fees some 33 times, a total of $3.6 billion in new taxes, from 2002 through 2004. Then his successor, Jon Corzine, increased taxes by $1.2 billion in 2006 after a showdown with the legislature that shut down state government. Neither of those moves did much to solve the state's decade-long budget woes, and in 2009 Jersey voters elected Chris Christie.

In 2010 Christie blocked efforts by the Democrat-controlled legislature to extend a temporary income tax surcharge on wealthy residents, in effect cutting the income tax by $600 million while also reducing state spending by 8.6 percent to balance the budget. Last year Christie signed into law some $347 million in business tax cuts, including a reduction in the minimum tax paid by small subchapter S corporations.

Of course, advocates for raising federal taxes point out that the landscape is far different in Washington than in many states. The federal government has accumulated $16 trillion in debt and a $1 trillion dollar deficit that threaten the country's future.

Yet one of the dangers we face is that Washington will repeat the mistakes of some tax-raising states, which chose to boost the burden on citizens without enacting fundamental spending reforms at the same time.

In January of 2011, for instance, Illinois raised income and corporate taxes a total of $6.5 billion to address its deficit and a backlog of unpaid state bills, but it did nothing to restrain the growth of its expensive Medicaid system or reform its pensions. Last year the Civic Federation, a Chicago good government group, estimated that about two-thirds of the Illinois tax increase was being consumed by higher state pension costs alone, leaving the state with continuing budget problems.

California appears headed in the same direction. In November Californians voted to raise the state's sales tax along with income taxes on wealthy state residents a total of nearly $7 billion. But the state has enacted only modest pension reforms that don't save much money and hasn't trimmed its expensive Medicaid program, whose costs are squeezing the state budget.

Prominent California Democrat David Crane, a former economic adviser to Gov. Arnold Schwarzenegger and a lecturer now at Stanford University, argued that raising taxes without first reining in spending is fruitless. "A tax increase without reform would be lethal," Crane maintained in an op-ed piece in the Sacramento Bee.

But that's what Californians have gotten.