The voices of Tax Policy Center's researchers and staff
When Congress passed the Tax Cuts and Jobs Act (TCJA) in December, it forced states to confront major tax policy issues of their own, and to do it in just a few months. The somewhat predictable result has been a mix of confusion, uncertainty, and questionable choices.
Because many states use the federal tax code in their own income tax systems (called conformity), some (but not all) of the TCJA’s changes will become state law unless states pass new legislation. Among them, the increased standard deduction and the eliminations of personal exemptions—but critically (with few exceptions) not the larger child tax credit (CTC).
Further complicating this, these changes apply to tax year 2018, which is part of each state’s current fiscal year (most run from July 1 through June 30). That means state legislatures, which typically are only in session for three or four months during the year, have little time to make big decisions about income tax issues they cannot push off to next year.
Utah is a good example. It uses the federal standard deduction and personal exemption on its return, but does not conform with the CTC. If Utah does not change its rules, the new combination of a larger standard deduction but no personal exemptions will increase taxes on large families. You would think the state with the largest average household size in the nation would move fast to prevent that. But Utah just ended its legislative session without fixing the problem.
Instead, Utah cut both its individual and corporate income tax rate from 5 percent to 4.95 percent. But while the rate cut benefits many Utah taxpayers, particularly high-income earners, many large low- and middle-income families will still wind up with a state income tax hike. A legislator who proposed a bill to keep personal exemptions (that went nowhere) said, “I think it felt better to be able to say we lowered your income taxes,” by which I can only assume he means rates.
If so, that sounds a lot like what happened in Idaho, which faced with the same problem also cut tax rates instead of keeping its personal exemption. But Idaho lawmakers realized their mistake and immediately passed a larger child tax credit to prevent a tax hike on large families. Utah still has time to follow its northern neighbor, but no special session is planned.
Other places that conform to the federal standard deduction and personal exemptions, such as Colorado, the District of Columbia, Minnesota, New Mexico, North Dakota, South Carolina, and Vermont face similar questions. None have responded so far, including a few where lawmakers have also already gone home for the year.
Meanwhile, Maryland kept its personal exemptions and made other changes to protect some taxpayer from tax hikes, but it left others exposed. Like 14 other states, Maryland requires filers to use the state standard deduction if they take the federal standard deduction. While Maryland increased its standard deductions this year to $2,250 for single filers and $4,500 for married couples, they are still well below the new federal levels of $12,000 and $24,000.
Many Maryland taxpayers who previously itemized on their federal returns will now take the new federal standard deduction. As a result, they’ll have to take the state standard deduction which is much lower than their past itemized deductions. The result: A state tax hike, mostly for middle-income households.
Maryland could change its law and allow taxpayers to itemize on their state income tax return even if they take the federal standard deduction. But that change would reduce revenue that Maryland already decided to spend on education or keep in reserve. Georgia also passed a major tax bill (that cut individual and corporate income tax rates and increased the standard deduction) in response to the TCJA without changing this rule.
Then there’s Kentucky, where rushed legislation upended political alliances. Kentucky doesn’t have major ties to the federal tax system, but it needed revenue right away—in part to help finance public schools. Plus, Gov. Matt Bevin promised a tax overhaul this year (“Tax reform is coming. It is coming.”).
And it did. Quickly. The state passed a tax overhaul in 11 hours.
The Republican legislative plan collapsed Kentucky’s six income tax brackets, with a top rate of 6 percent, into a flat 5 percent rate, and imposed sales taxes on many purchased services that until now had been exempt, such as dry cleaning and auto repairs.
Supporters say it will raise nearly $500 million over the two-year budget period, but critics correctly note that while it substantially cuts taxes for high-income Kentuckians, it raises taxes for nearly everyone else (some will pay a little more in income tax and everyone will pay more in sales taxes). The Republican governor vetoed the bill because he said it would not raise enough revenue, claiming estimates were off nearly $100 million. The Republican-controlled House and Senate, with the support of the state’s teacher’s union that desperately wanted the funds, overrode his veto.
With ongoing revenue questions, Kentucky could soon be back at this, and it will have company. Oklahoma also pushed through a tax hike this year but still might not have enough revenue for desired education spending increases. Kansas, which had its tax reckoning last year, just passed an education increase but didn’t say who is paying for it.
States are facing tough choices with little time to make them. Some may try again in special sessions later this year. Others may leave laws in place until legislatures meet again in 2019, at which point their constituents might notice some of these questionable state tax decisions as they file their income tax returns for 2018. Regardless, tax policy won’t get any easier for states any time soon.
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Rick Bowmer/AP Photo