Why Are States Unplugging from the Federal Tax Code?

June 15, 2005

States have traditionally followed the lead of the federal government when setting tax rules. But in recent years, states have started going their own way—something tax experts call “decoupling” of state and federal tax codes.

Why are states decoupling? Largely because the federal government has been cutting taxes, and cash-strapped state governments aren’t eager to follow suit—especially when it comes to repealing estate taxes and liberalizing depreciation rules. From a recent Inc magazine piece:

For most of the 92 years since the federal income tax was established, the states followed Washington’s lead concerning how to tax people and businesses. That ended in 1981, when 21 states adopted their own rules on depreciation in response to a Reagan tax cut… When Congress began slashing federal rates in 2001, many cash-strapped state legislatures opted to go their own way once again…

“The states can always raise tax rates, but they don’t like having to say that they’re raising rates. Decoupling makes it easier to mask an increase in taxes,” says Alan Kaden, a tax attorney at the firm Fried, Frank, Harris, Shriver & Jacobson in Washington, D.C. “As revenues become scarcer and states are under pressure, more will do this.”

One unfortunate side effect: decoupling creates a tax complexity nightmare for companies operating in multiple states with inconsistent tax rules. For more on the costs of tax complexity, check out our Tax Complexity & Compliance Costs section.

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