Skip to content

How Would Expiration of Bush-Era Tax Cuts Affect State and Local Budgets?

2 min readBy: Mark Robyn

Download Special Report 187

Special Report 187


While the U.S. economy continues its slow crawl towards recovery, many states are cur­rently in budget limbo. Last year’s stimulus bill saved state lawmakers from some politically painful fiscal adjustments, but another federal windfall is unlikely. States are wondering where to go for more revenue and what can be cut from outlays. Here we discuss how the major 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. policy question of the day, the expir­ing Bush tax cuts, could affect states at this already tight time.

We highlight four main areas of interac­tion between state finances and the expiring tax cuts. First we discuss how potential changes in federal tax law would change state and local income tax revenue, both directly and in more subtle, interactive ways. Secondly, we discuss the impact on state estate taxes if the federal estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. is revived after its one-year repeal in 2010. Third, because higher taxes mean less money in peoples’ wallets, we discuss the impact of various federal tax policy options on state and local sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. collections. Finally, we discuss how the Bush tax cuts could affect the financial condition of the federal government as well as the macroeconomy, and the likely con­sequences for state and local finances.

Key Findings

• Many state income tax systems piggy-back off the federal income tax. Due to potential changes in 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. , adjusted gross incomeFor individuals, gross income is the total pre-tax earnings from wages, tips, investments, interest, and other forms of income and is also referred to as “gross pay.” For businesses, gross income is total revenue minus cost of goods sold and is also known as “gross profit” or “gross margin.” , child tax credits and earned income tax credits, states that are linked closely to the federal tax code will see an automatic uptick in revenue if the Bush tax cuts expire.

• The handful of states that allow a deduction for federal income taxes paid are likely to see a revenue loss if federal income taxes increase, even after accounting for other revenue-increasing effects.

• “Interactive” effects from the expiration of the Bush tax cuts, either in January 2011 or some later date after a temporary extension, include a decrease in the value of the federal deduction for state and local taxes; a reduction in state revenues due to shrinking income and sales 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. s; and changes in tax planning by filers.

• If the federal estate tax returns there would be an automatic return of the estate tax in many states that are linked to the federal estate tax.

• Congress’s actions on the Bush tax cuts could affect the federal and state budget conditions in the long term. We briefly discuss the consequences for states of a possible federal value added tax, the possibility that declining federal credits could hurt the states’ ability to borrow, and the potential macroeconomic impacts of Congress’ handling of the Bush tax cuts.