States facing down budget deficits are likely to be tempted to employ tax hikes as a way to make the budget math work. But this siren song could threaten the recovery from the economic circumstances causing the budget issues in the first place.
It’s true that state revenues are down substantially due to the pandemic and its associated lockdowns. According to the National Association of State Budget Officials (NASBO), total state revenues are down byabout 3 percent year-over-year, with gaming and corporate income revenues taking the largest dips.
Three percent may not sound like a ton, but considering that NASBO anticipated state revenues increasingby 3.4 percent in FY 2020 prior to the pandemic, the gap is larger than it might first appear. At the same time, state spending has had to increase to combat a pandemic and fund increased unemployment claims.Massive federal aid has helped a great deal, but some analysts are still projecting cumulative state budget shortfalls of about $400 billion.
Historically, states have responded to recession-induced budget shortfalls with tax hikes, as happened during the 2008 recession. Though it’s easy to see why states do this, it’s a response that could work to extend the period of financial insecurity for state budgets.
Back in August, I chronicled some of the ways that states had thought about raising new revenue. These proposals included California hiking its top income tax rate by 3.5 percentage points, a “wealth tax” in the Golden State, a New York proposal to implement so-called “mark-to-market” taxation of certain assets, among others.
But when it comes to harmful tax proposals, states are never short on ideas. The Multistate Tax Commission, an interstate tax agency formed by 47 cooperating states, recently suggested that they may soon pursue new gross receipts taxes as a means of collecting new revenue.
Only seven states currently impose some form of gross receipts tax, and there’s good reason most states avoid them. Gross receipts taxes cause a great deal of “tax pyramiding” (basically, assessing tax on top of tax) as business-to-business transactions are taxed, and there is no recognition of the fact that some businesses operate on lower profit margins than others. While gross receipts taxes raise more revenue than sales or corporate income taxes, it’s because they tax business receipts that are rightly exempted by these other types of taxes.
Another potential misstep by states would be decoupling from the federal government’s recent tax reform law. The Tax Cuts and Jobs Act (TCJA) included some new tax breaks which may have cost states revenue to implement, but they were focused on expanding corporate investment and altering the incentive structure which encouraged multinational corporations to offshore. Not only would decoupling threaten these positive tax changes, but it would create headaches for businesses forced to deal with opposing tax rules at the federal and state level.
States are also going after digital advertising tax revenue as well. The momentum on digital ad taxes was stalled somewhat by the onset of the pandemic, but the idea has not died. Not only could digital ad taxes endanger the system which enables hundreds of millions of consumers to access free internet services funded by advertising, but they are legally dubious and would likely embroil states in expensive litigation.
Unfortunately, there’s also plenty of push for tax hikes of the more mundane variety. The National Taxpayers Union has catalogued more than 2,300 ballot measures up for consideration on November 3, most of which are proposed tax or spending increases.
Logical as it may seem to state budget officials that they need to make up “lost” revenue with new taxes, it runs the risk of extending the period of recovery necessary. As recent economic data shows, the country is well on its way to a strong recovery. Rocking the boat at a time when the economic forecast is looking up is hazardous not just to state budgets, but also to American workers hoping to see the economy get back to its pre-pandemic strength.