The November elections surprised many at the federal level, and the same is true at the state level: what was thought to be a possible ‘blue wave’ in the statehouses did not materialize. However, combined with significant tax ballot measures and continuing fiscal pressures due to COVID-19, these election results will influence state tax policy in 2020 and beyond.
While the state election results generally reflect the status quo, these elections will have a significant impact on the state revenue outlook and states’ approaches to tax policy.
First, the federal elections will impact the timing and degree of COVID-19 related aid. Many states, particularly larger states with significant fiscal difficulties, are looking to federal aid to help write their 2022 fiscal year budgets. An absence of additional federal aid -- or federal aid that falls short of these states’ expectations or that is restricted in its use -- could spur consideration of tax increases in the 2021 legislative sessions.
Changes in state government control, to the limited extent that happened in Montana and New Hampshire, could have an impact in the direction of state tax policy in those states. Montana in particular has had a Democrat as governor for the past 16 years.
Changes in leadership and incremental changes to the partisan makeup of legislatures also have an impact. While some states’ legislatures have remained largely the same after the elections, others have seen Democrats or, more often, Republicans pick up additional seats.
A New York Senate supermajority for Democrats could have state tax policy repercussions notwithstanding that Democrats have trifecta control over state government. With certain Democrat incumbents either retiring or not holding their seats in the primaries, this will make more likely the consideration of progressive policies in the legislature next year and beyond.
Finally, there were many significant state and local tax ballot measures around the country. The highest profile failures -- California’s split roll property tax and Illinois’ graduated income tax -- likely will prompt those states to look to other revenue sources in their upcoming sessions. Further, those failures likely spell the end of consideration of those particular policies for the foreseeable future, as voters rejected these structural tax changes that require constitutional amendment.
There were some tax ballot successes, however, and perhaps most notable was the simultaneous approval of an income tax cut in Colorado and an income tax hike in Arizona, both of which will impact tax policy in those states in the coming years. The success of marijuana legalization also has prompted other states to examine this policy for potential tax revenue and a possible answer to the COVID-19 revenue downturn.
States have seen an uneven impact to their tax revenues as a result of the COVID-19 pandemic. States with the largest shortfalls have volatile revenue sources (e.g., severance taxes on oil or very progressive income taxes) or severely impacted industries (such as tourism and energy). Further, the severity of the downturn has been impacted by the pandemic’s public health impact and the states’ varying responses.
However, the revenue picture is beginning to look up for the states overall. Part of this is driven by gains in the stock market and improved individual income tax receipts. How the continuing pandemic unfolds and the federal response, including unemployment and other aid, will impact future state tax receipts. Further, just as the impact of the downturn is not uniform, the recovery is not uniform, nor is the recovery in many states sufficient to cover the massive downturn that began in March.
State revenue responses have been limited to date, but they provide insight into how other states may react. This year, many states patched budget holes (at least on paper) with a combination of tapping rainy day funds, accounting maneuvers, borrowing, federal aid, and spending cuts. However, some states have taken actions based on prior policies that could be imitated by other states.
For example, California looked to its policy playbook from the last recession and, as part of its 2021 fiscal year budget, enacted a net operating loss suspension and credit limitation. In particular, a credit suspension was embraced by New York during the last recession, and this is a policy to watch along with scrutiny of credits and incentives nationwide.
New Jersey in September extended and increased its corporate surcharge and levied a “millionaire’s tax.” Expect corporate and high-income individual tax increases to be considered in other states, including California and New York. These and other states may look to other policies -- such as wealth taxes, stock transfer taxes, excess profits taxes, and CEO pay ratio taxes -- to target enterprises and individuals that are seen as prospering during the pandemic.
There will be a countervailing current, however, as states seek to incentivize investment and aid economic recovery. This will temper the push to enact some of these tax priorities. In some states -- including Mississippi and West Virginia -- there is even discussion of phasing out the individual income tax. Such discussions often raise concerns about replacement revenue, including from consumption or gross receipts taxes.
Adoption of statewide gross receipts taxes this coming year appears unlikely, but we could see such measures adopted as a temporary alternative minimum tax. Large-scale expansion of the consumption tax base also is unlikely, as sweeping services taxes have met defeat in prior years when the extent of their reach is examined by legislators. Expect more targeted measures on exemptions and specific services, in particular business-to-business services. One policy to watch is digital advertising taxes; a bellwether could be the potential override in January of the Maryland governor’s veto of S.B. 2. Other states have considered measures to imitate Maryland’s policy, in particular New York.
The upcoming legislative session promises to be an active one, with many competing priorities for policymakers. Individuals and businesses need to monitor tax proposals during the fast-paced state sessions and leading up to the states’ budget deadlines -- and beyond. This coming budget season will be unique, with health and fiscal conditions shifting the ground under legislators’ feet. Don’t be surprised to see a second round of policymaking if the pandemic produces continued economic disruption or if economic conditions worsen despite a public health improvement.
What can taxpayers do beyond staying abreast of tax developments? Analyzing your portfolio and business footprint, applying potential policy changes, and modeling impacts are key to staying ahead of a rapidly changing and uncertain environment. With residency and business decisions in flux due to COVID-19, understanding your position and the potential tax consequences of your actions has never been more vital.