Flush with cash, states planning big cuts to taxes

SAN DIEGO - State lawmakers preparing to convene legislative sessions in the new year are confronted with a scenario unlike any they, or most of their predecessors, have ever experienced: budgets that are flush with cash after a year of record-setting surpluses.

The influx of new money, fueled by a quick economic recovery from the coronavirus pandemic and billions in emergency federal funding for state and local governments, has spurred new talk of significant tax cuts. Across both blue states and red states, and just in time for midterm elections, legislators and governors are making plans to lower rates and cut bills.

"States are doing so much better than they were this same time in 2019," said Katherine Loughead, a senior policy analyst at the nonpartisan Tax Foundation. "A lot of state budget officers are seeing projected revenue growth for the next couple of fiscal years. So while it's important to be cautious about revenue, states are back on a growth trajectory that they were on before the pandemic. A lot of states are looking for more ways to become more attractive to workers."

The cuts have already begun.

A dozen states this year introduced measures to reduce corporate or personal income rates, and a 13th - Arkansas - will consider cutting rates in a special session. Another half a dozen states added tax exemptions for federal stimulus money or unemployment payments or reduced property and service taxes.

"Income tax cuts were the main trend we saw this year, and that looks like it will continue to be a trend going in 2022," Loughead said.

The governors of Minnesota and Wisconsin proposed tax increases, but both signed budgets that ultimately cut taxes. Only five states - Florida, New York, New Jersey, Washington and Missouri - raised or created new income or sales taxes.

The proposed cuts next year go beyond income taxes. Kansas Gov. Laura Kelly (D) and Virginia Gov.-elect Glenn Youngkin (R) have both proposed cutting taxes on groceries.

And some states have already enacted longer-term plans that will phase in cuts. North Carolina Gov. Roy Cooper (D) and Arizona Gov. Doug Ducey (R) this year signed budget deals that will gradually reduce tax rates over a series of years.

The budget Cooper signed, passed by a Republican-controlled General Assembly, was not entirely to his liking. In remarks as he approved the package, he said he wished the cuts had been directed elsewhere.

"The legislature directs future tax breaks more toward corporations and the wealthy rather than the middle class and lower-income North Carolinians," Cooper said last month.

But the move to create phased-in cuts over a period of years is gaining steam among lawmakers who want to cut without digging themselves into a hole from which they must climb out.

"Our approach to tax reform has always been, it's a marathon," North Carolina state Rep. Jason Saine (R), chairman of the state House Appropriations Committee, said in an interview on the sidelines of the American Legislative Exchange Council meetings here last week. "Too big a change could disrupt too much. So I think we had a very pragmatic approach to it."

After a decade of painfully slow recovery, in which legislators had to cut services to the bone in the wake of the Great Recession and then saw state revenues come back at a trickle rather than a flood, the new reality of big surpluses has shocked many.

Minnesota's Department of Management and Budget said Tuesday the state had $7.7 billion in extra money. Missouri's budget surplus will top $4 billion. Utah and Rhode Island expect to have an additional $600 million each. Idaho officials say they have $1.4 billion in extra money. Iowa closed the books on its last fiscal year with a $1.2 billion surplus.

"We've got to send money back to the taxpayers," said Iowa state Rep. John Wills (R), the House Speaker pro tempore, who said he expects the already-huge surplus to grow. "I'd like to see us go down a flat tax and maybe even start pointing ourselves to no [income] tax."

In California, budget officials expect to have a whopping $31 billion - so much extra money that the state could be forced by existing law to give billions directly back to taxpayers.

"That [surplus] allows us to do things unprecedented in California's history, and that is, invest in you," California Gov. Gavin Newsom said at the California Economic Summit in November.

Some states are considering longer-term changes to tax codes that could have ramifications years down the line. Kansas Senate President Ty Masterson (R) said he wanted to see a wholesale change to the way his state implements new taxes, along the lines of the Taxpayer Bill of Rights that passed in places like Colorado in the 1990s.

"I would personally like to see some taxpayer protection passed just along the lines of [requiring] a supermajority for tax increases," Masterson said in an interview. "There's just the broader sense that you should just cut across the board, you know, more people paying lower rates instead of these precise tax cuts."

Legislators and budget experts cautioned that the better-than-expected fiscal outlook for states is temporary, and that the last decade of tight belts and tighter budgets is likely to return at some point. Of the current surpluses, billions are one-time funds that come from the federal government's coronavirus relief packages, money that will not materialize again. Over-cutting now could make future fiscal crises all the more acute.

"Permanent tax changes may pose fiscal challenges if they are driven primarily by one-time revenue surpluses, and states with weaker levels of financial resilience due to low reserves or rainy-day funds are more at risk," the analysis firm FitchRatings wrote in October.

But the heady experience of having billions to spend - or cut - is enticing for lawmakers who have spent most of their careers cutting services and tightening budget belts.

"You print trillions of dollars, it all flows through the system," Kansas's Masterson said. "It's not going to be as simple as people may think."