States are flush with cash, but 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. payers’ purchasing power is being eroded by high inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. . It’s unsurprising that many policymakers have jumped at the chance to apply surpluses to meet the genuine needs of many residents—but good intentions do not always make for good policy.
Tax rebates, gas tax holidays, and other temporary tax expedients have the potential to add to existing inflationary pressures while doing relatively little to help those in need. Whereas long-term tax relief or structural reform changes incentivize structures to encourage investment, enhance labor participation, and boost productivity, short-term relief pumps additional money into an environment that is already highly inflationary.
In Georgia, Gov. Brian Kemp (R) recently signed legislation providing $1.1 billion worth of tax rebates, in the form of $250 to $500 per household checks (capped at actual tax liability). Earlier this year, Idaho Gov. Brad Little (R) signed into law a broader tax package that includes one-time tax rebates of 12 percent of tax liability or $75 per taxpayer and dependent, whichever is greater. In California, Gov. Gavin Newsom (D) has proposed sending $400 to every vehicle owner in the state (capped at $800 per household) to defray the higher cost of gasoline. New Mexico Gov. Michelle Lujan Grisham (D) plans to call a special session centered around economic relief, with proposals emerging to issue tax rebate checks. And gas taxA gas tax is commonly used to describe the variety of taxes levied on gasoline at both the federal and state levels, to provide funds for highway repair and maintenance, as well as for other government infrastructure projects. These taxes are levied in a few ways, including per-gallon excise taxes, excise taxes imposed on wholesalers, and general sales taxes that apply to the purchase of gasoline. holidays—for now or later in the year—have been approved in four states and counting.
Sending one-time checks to taxpayers is not new. The federal government sent multiple rounds of checks since the pandemic began, of course. During the Great RecessionA recession is a significant and sustained decline in the economy. Typically, a recession lasts longer than six months, but recovery from a recession can take a few years. , most taxpayers received a refundable tax creditA refundable tax credit can be used to generate a federal tax refund larger than the amount of tax paid throughout the year. In other words, a refundable tax credit creates the possibility of a negative federal tax liability. An example of a refundable tax credit is the Earned Income Tax Credit. in 2008 and certain SSI recipients received a $250 payment in 2009. Before that, the 2001 Bush tax cuts included $300/$600 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, and 1975 legislation provided a rebate of 10 percent of taxes paid the previous year, up to a maximum of $200.
In surveys, 25-30 percent of recipients tend to indicate that they will spend the additional money, compared to saving it or using it to pay off debt. Economic studies tend to support moderately higher levels of additional consumption than is self-reported in these surveys.
In the past, however, most one-time spending through the tax code was in response to an economic downturn, and thus typically came at a time when consumer spending was below average, and when the money was intended to help people keep up with ongoing expenses.
The year of the 2001 tax cuts, consumer spending increased a modest 1.6 percent. It declined about 1 percent per year in 2008 and 2009, when further payments were made. In 1975, it simply recovered to what it had been before a dip in 1974. Last year, by contrast, consumer expenditures soared more than 7 percent, and are about 4 percent higher in real terms than they were before the pandemic. Personal income, meanwhile, is up 8 percent (inflation-adjusted) since 2019, boosted by both direct and indirect federal assistance.
And in perhaps the most shocking number of all, consumption expenditures on goods are up an astonishing 17 percent in real terms since the pandemic began, whereas demand for services has declined slightly. Rebate checks or tax holidays in 2022 come against the backdrop of high inflation, yes, but also all-time highs in income and consumption.
Critically, consumers aren’t just paying more—they’re buying more. Despite—and in fact contributing to—supply chain breakdowns, container throughput in major U.S. ports broke records in 2021. Prices are high, in part, because supply is having trouble keeping up with demand, especially for physical goods. Additional one-time transfers put even more pressure on the system. Even if taxpayers put only a fraction of the money toward additional consumption, the result is more demand-side pressures when there are already supply shortages.
Long-term tax relief also puts more money in taxpayers’ pockets, of course, but with a very different incentive structure. Permanent rate reductions or structural reforms create a higher return to labor and investment, and thus promote economic growth. By contrast, while a one-time payment induces some economic changes, it does not, by definition, change long-term planning. More money retained by taxpayers under long-term reforms will be accompanied by changes in labor supply, productivity, and capital investment, increasing supply as well as demand.
Even if one-time tax rebates are not particularly economically efficient, it isn’t unreasonable for policymakers to prefer them to unnecessary one-time government spending, or—worse—to use one-time revenue gains for long-term spending increases. Such policies can have their place. But their ordinary inefficiencies are magnified in a high inflation environment.
What should lawmakers do instead?
For starters, they should evaluate whether they have the capacity for actual tax reform, not just one-time relief. Most states project sustained revenue growth that could fund real reform or rate reductions, not just one-time transfers. At the same time, however, states need to distinguish between those long-term growth trajectories and the unusually large (and unsustainable) surpluses they have right now, the latter being the source of most one-time relief proposals.
After that, they should fully fund reserves. Most “rainy day funds” are in good shape right now, since they did not need to be tapped during the pandemic, but if there’s any room to top them off, it is prudent to do so. Many states have pension funds to shore up as well. Additionally, some states have taxpayer relief trust funds into which deposits are made in good years so that the government has some buffer to phase in tax reforms in the future. Setting aside some of today’s surpluses for more meaningful tax relief at a later date could prove far more pro-growth than writing checks today.
State policymakers understandably want to use whatever tools they have at their disposal to address rising consumer costs, but tax rebates and gas tax holidays have the potential to contribute to the problem they are intended to solve.
Even if states can’t fix inflation for their residents, though, they can make sure that inflation doesn’t come paired with an unlegislated state tax increase. For states with graduated-rate income taxes, there’s no time like the present to inflation-adjust state tax codes to avoid bracket creepBracket creep occurs when inflation pushes taxpayers into higher income tax brackets or reduces the value of credits, deductions, and exemptions. Bracket creep results in an increase in income taxes without an increase in real income. Many tax provisions—both at the federal and state level—are adjusted for inflation. .