Many states’ annual revenue projections have increased following enactment of federal taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. reform last December. That is because the Tax Cuts and Jobs Act (TCJA)The Tax Cuts and Jobs Act in 2017 overhauled the federal tax code by reforming individual and business taxes. It was pro-growth reform, significantly lowering marginal tax rates and cost of capital. We estimated it reduced federal revenue by .47 trillion over 10 years before accounting for economic growth. broadened the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. –or expanded the sources of income that are subject to federal income taxation–and most states conform in large part with the federal income tax base.
Specifically, with respect to individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. es, most states use either federal adjusted gross income (AGI)Adjusted gross income (AGI) is a taxpayer’s total income minus certain “above-the-line” deductions. It is a broad measure that includes income from wages, salaries, interest, dividends, retirement income, Social Security benefits, capital gains, business, and other sources, and subtracts specific deductions. or federal taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. as the starting point for calculating a taxpayer’s state income tax liability, so changes to certain federal deductions and exemptions flow through to state income tax returns and impact the amount of income that is subject to taxation.
Unless and until state lawmakers modify state tax codes to offset revenue gains from federal base broadeningBase broadening is the expansion of the amount of economic activity subject to tax, usually by eliminating exemptions, exclusions, deductions, credits, and other preferences. Narrow tax bases are non-neutral, favoring one product or industry over another, and can undermine revenue stability. provisions, most states can expect to see a net revenue increase under the new law. Many states have quantified the amount of revenue they expect to gain or lose based on how their longstanding Internal Revenue Code (IRC) conformity statutes interact with the TCJA. We have compiled these revenue estimates on our website as they have been announced.
States that expect to see a net revenue increase have three options in deciding how to use new revenue; my colleague Jared Walczak has called them the “Three Rs of Tax Conformity”: Retain, Return, or Reform. States can retain the additional revenue, which amounts to an implicit tax increase; they can return the revenue to taxpayers by reducing rates or decoupling from federal provisions responsible for the additional revenue; or they can reform their tax codes, using the revenue gains to adjust rates and create a tax structure that is more conducive to economic growth.
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During the 2018 legislative session, five states took the latter approach, using federal tax conformity legislation as an opportunity to enact state tax reform. These accomplishments are recapped below:
- Georgia: Anticipating a revenue increase of $5.2 billion over five years, the legislature passed House Bill 918, tax reform legislation that was signed into law by Governor Nathan Deal (R) in March. This law reduces the top individual and corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. rates from 6 percent to 5.75 percent in 2019 and doubles the standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. . In addition, this law outlines steps to further reduce both rates to 5.5 percent pending passage of a joint resolution ratifying such language in 2020. You can read more about Georgia’s tax reform law here.
- Idaho: Anticipating a $97.4 million increase in revenue in fiscal year (FY) 2019 due in large part to the state’s conformity with the federal personal exemption (which was eliminated in the TCJA), Idaho lawmakers realized that doing nothing would result in an unintended tax increase. As a result, the House and Senate passed House Bill 463, which was signed into law by Governor Butch Otter (R) in March. This law retains conformity with the TCJA’s repeal of the personal and dependent exemptions, incorporates the TCJA’s higher standard deduction, reduces the individual income tax rate by 0.475 percentage points across all marginal income tax bracketA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat. s, and reduces the corporate income tax rate by 0.475 percent. Read more about Idaho’s tax reform law here.
- Iowa: The Iowa Department of Revenue projected $188.3 million in increased revenue due to the TCJA. After initially weighing the idea of reducing rates without enacting substantive reforms, Iowa lawmakers ultimately opted for comprehensive tax reform, fully restructuring the state’s tax code to better promote economic growth. In May, Governor Kim Reynolds (R) signed Senate File 2417 into law, bringing much-needed reform to a tax code that was previously one of the worse structured in the country. This tax reform package consolidates Iowa’s nine individual income tax brackets into four and lowers the top rate from 8.98 to 6.5 percent. It also eliminates the alternative minimum tax (AMT)The Alternative Minimum Tax (AMT) is a separate tax system that requires some taxpayers to calculate their tax liability twice—first, under ordinary income tax rules, then under the AMT—and pay whichever amount is highest. The AMT has fewer preferences and different exemptions and rates than the ordinary system. and fully conforms with federal itemized and standard deductions, among other changes. This law incorporates many of the reforms we recommended for the state in 2016, including an eventual repeal of the state’s unusual deduction for federal taxes paid and a reduction of the highest-in-the-nation corporate income tax rate from 12 percent to 9.8 percent by 2021. Click here to read a detailed overview of the new law.
- Missouri: Governor Mike Parson (R) signed House Bill 2540 into law in July. This tax reform law reduces the top individual income tax rate from 5.9 to 5.4 percent in 2019 and includes triggers to reduce the rate to 5.1 percent subject to revenue availability. The law also partially phases out high earners’ federal deductibility, which has historically allowed Missouri taxpayers to deduct a portion of their federal tax liability from their income when calculating state liability. Combined with legislation enacted earlier this year giving the state a 4 percent corporate tax rate, this conformity and tax reform package will help Missouri stand out among its peers. Read more here.
- Utah: Utah adopted House Bill 293 in March, which reduced individual and corporate income tax rates slightly, from 5 percent to 4.95 percent, as well as increased the state’s homeowner’s and renter’s tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. s. In a July special session, the state approved a $30 million expansion of the state’s child tax credit, which is expected to reduce families’ income tax liabilities by approximately $34 per dependent.
Georgia, Idaho, Iowa, Missouri, and Utah wasted no time capitalizing upon the TCJA’s base broadening provisions to offset the cost of rate reductions, simplifications, and other sensible changes to the structure of their tax codes. While every state but Massachusetts has adopted a budget for fiscal year 2019, states that have not yet grappled with the new revenue from federal tax reform will have another opportunity to do so next year. Some have yet to conform to the new law’s base-broadening provisions and may explore opportunities to reform their tax codes as they capture that new revenue. But even states that have already conformed may choose to return some or all of the additional revenue to taxpayers with the benefit of an additional year to consider options. Whether additional states use any new revenue for tax reform will be something to watch out for during the next legislative session.Share