Instead of Fighting Tax-Cutting States, Feds Should Follow Their Example

COMMENTARY Taxes

Instead of Fighting Tax-Cutting States, Feds Should Follow Their Example

Jan 9, 2023 6 min read
COMMENTARY BY
Preston Brashers

Senior Policy Analyst, Tax Policy

Preston is a senior policy analyst for tax policy in The Heritage Foundation’s Grover M. Hermann Center for the Federal Budget.
High taxes—especially taxes on income—destroy entrepreneurship, bog down businesses, drive out jobs, and sap families of their wealth and well-being. maxexphoto / Getty Images

Key Takeaways

In the face of all the dysfunction in Washington, dozens of states have been busy cutting taxes for individuals and businesses.

This is all happening despite Congress’ brazen attempt in 2021 to block states from cutting taxes—or at least limit their ability to do so.

High taxes—especially taxes on income—destroy entrepreneurship, bog down businesses, drive out jobs, and sap families of their wealth and well-being.

With Congress continuing its nearly three-year-long inflation-driving spending spree and adding several new federal taxes—not to mention 87,000 new IRS agents—it’s easy to miss a fascinating subplot that will help soften the blow in many states.

In the face of all the dysfunction in Washington, dozens of states have been busy cutting taxes for individuals and businesses.

Iowa just cut its personal income tax rate from 8.53% to 6%, reduced its corporate income tax from 9.8% to 8.4%, and is phasing out its inheritance tax.

Missouri brought its individual income tax rate down from 5.3% to 4.95%. Pennsylvania just cut its corporate income tax rate from 9.99% to 8.99% and plans to reduce the tax to 4.99% by 2031.

The list goes on.

This is all happening despite Congress’ brazen attempt in 2021 to block states from cutting taxes—or at least limit their ability to do so.

The American Rescue Plan doled out $350 billion to state and local governments in all 50 states, but included a provision stipulating funds couldn’t be used to “either directly or indirectly offset a reduction in the net tax revenue of the state or territory.”

If interpreted broadly, this “tax mandate” provision would allow the Treasury Department to reclaim funds from any state that cut taxes in the years following the passage of the American Rescue Plan.

After all, it would be hard for a state to prove that a payment received didn’t indirectly offset a reduction in revenue. Negative numbers and positive numbers do offset one another.

However, a de facto prohibition on state tax cuts would be coercive, inconsistent with Congress’ enumerated power of “providing for the … general welfare of the United States”—and clearly unconstitutional.

Treasury’s interpretation of the tax mandate doesn’t go quite that far, giving states some leeway to cut taxes up to a de minimis threshold or to reduce taxes if increased revenue from economic growth sufficiently offsets the cuts.

Nonetheless, these rules—which make the Treasury Department the arbiter of which state tax cuts are permissible—face vigorous legal challenges from more than a dozen states.

States aren’t waiting for the courts to settle the issue.

ArkansasArizonaIdahoIndianaIowaKentuckyLouisianaMississippiMissouriMontanaNebraskaNew HampshireNorth CarolinaOhioOklahomaPennsylvaniaSouth Carolina, and Utah have all reduced individual or corporate income tax rates since 2021, with many of those changes having taken effect Sunday.

Lawmakers in those states understand something that federal lawmakers don’t. High taxes—especially taxes on income—destroy entrepreneurship, bog down businesses, drive out jobs, and sap families of their wealth and well-being.

Americans consistently show their preference for low taxes instead of more government spending year-after-year by the steady stream of people moving out of high-tax states, such as California and New York, and into low-tax states, among them Florida and Tennessee.

Unfortunately, many of the high-tax states whose economies would benefit most from lower taxes instead continue to plow more and more into government spending.

California is a prime example.

California Gov. Gavin Newsom led calls for the state bailouts in 2020, pointing to a massive budget shortfall that his state faced. California’s state and local governments were ultimately rewarded with $35 billion of direct federal aid, not counting tens of billions of dollars of COVID-19 aid to individuals and businesses that ultimately flowed into California’s government coffers.

But after taking in record surpluses in the 2021 bailout year, California has already managed to spend itself back into a giant hole. With federal COVID-19 money drying up and a faltering technology sector, California faces a projected $24 billion budget shortfall in 2023.

In the not-unlikely event of another recession next year, the state’s Legislative Analyst’s Office expects $30 billion to $50 billion less revenue, implying a deficit of $54 billion to $74 billion. In other words, California could have a deficit that’s larger than almost any other state’s entire budget.

At this rate, how long will it be until California demands another bailout?

If federal lawmakers and officials had any sense, they’d be more concerned about the overspending and fiscal irresponsibility of states like California instead of trying to dictate which state tax cuts are acceptable.

But with $31.4 trillion of debt and counting, the federal government is in no position to criticize anyone else’s fiscal irresponsibility—not even in California, the federal government’s kindred spirit in fiscal insanity.

And it’s downright ridiculous that federal officials—who can’t keep their own fiscal house in order—would stand in the way of state lawmakers trying to give taxpayers some small refuge from the high taxes and inflation caused by runaway federal spending.

This piece originally appeared in The Daily Signal