Federal Tax Reform and Its Effect on State Budgets. August 10, 2017 Kim S. Rueben

Transcription

1 Federal Tax Reform and Its Effect on State Budgets August 10, 2017 Kim S. Rueben

2 The future for states is cloudy with a chance of storms. John Hicks National Association of State Budget Officers Jan. 26, 2017

3 States in the Trump era 1. Where are State Budgets? 2. Federal Proposals 3. How does this affect states? 4. What s next? 2

4 State of state budgets Still recovering from the Great Recession and grappling with troubling fiscal conditions even before considering federal action

5 State budgets still recovering from recession 4

6 Revenue Shortfalls expected 5

7 What is putting pressure on state budgets? Revenue Evolving economy: service economy, online sales, gig economy Policy decisions: income tax cuts Expenditures Health care costs Education mandates Both: Aging population Federal Actions More uncertainty from potential federal action 6

8 Many states have lowered revenue forecasts in the wake of tax revenue shortfalls and we expect more to do so. Rockefeller Institute of Government May 2017

9 Federal Tax Reform

10 President Trump s Latest Tax Reform Plan Complete White House Memo Released 26 April 2017 Tax Reform for Economic Growth and American Jobs The Biggest Individual And Business Tax Cut in American History Goals for Tax Reform Grow the economy and create millions of jobs Simplify our burdensome tax code Provide tax relief to American families especially middle-income families Lower the business tax rate from one of the highest in the world to one of the lowest Individual Reform Tax relief for American families, especially middle-income families: 1. Reducing the 7 tax brackets to 3 tax brackets for 10%, 25% and 35% 2. Doubling the standard deduction 3. Providing tax relief for families with child and dependent care expenses Simplification: 1. Eliminate targeted tax breaks that mainly benefit the wealthiest taxpayers. 2. Protect the home ownership and charitable gift tax deductions. 3. Repeal the Alternative Minimum Tax. 4. Repeal the death tax. Repeal the 3.8% Obamacare tax that hits small businesses and investment income. Business Reform 15% business tax rate Territorial tax system to level the playing field for American companies One-time tax on trillions of dollars held overseas Eliminate tax breaks for special interests Process: Throughout the month of May, the Trump administration will hold listening sessions with stakeholders to receive their input and will continue working with the House and Senate to develop the details of a plan that provides massive tax relief, creates jobs, and makes America more competitive and can pass both chambers. 11

11 Tax Cut Proposals Would Boost GDP in the Short Run, But not the Long Run GDP in trillions of $ Current Policy Trump House GOP Source: Penn-Wharton Budget Model and Tax Policy Center 14

12 Both Tax Proposals Would Disproportionately Benefit High-Income Households Percent change in after-tax income, by income group, Trump House GOP Lowest quintile Second quintile Middle quintile Fourth Top 1 quintile percent Income Quintiles (left) and Percentiles (right) Top 0.1 percent 15

13 Federal tax reform and the states SALT, corporate income taxes, and federal budget fallout from tax cuts

14 State and Local Tax Deduction 17

15 SALT repeal and the Northeast 18

16 What if SALT is repealed? Effect on federal revenue: Raise $1.3 trillion over 10 years (Treasury) Effect on taxpayers: 81% of filers with income over $100,000 claim SALT deduction; while only 10% of filers with income under $50,000 claimed SALT SALT repeal increases tax for current beneficiaries (inc 84% of taxpayers subject to the AMT) However, most households would get a tax cut with the largest amounts going to the highest income households. Though about 20% of taxpayers will face tax increases under Trump s proposal and they are more likely to live in state s with higher state taxes including CT, MD, MA, NJ and NY Effect on states: Depends on state actions 19

17 Effect on states Two ways to think about impact of repeal of SALT deduction: 1. SALT is a subsidy for states Cut state taxes; move away from progressive income taxes to regressive sales taxes as defacto cost to itemizers has increased 2. Larger federal tax changes mostly benefit highincome taxpayers and hurt budgets Raise taxes on high-income taxpayers to fill budget gaps created by federal cuts Reactions to recent federal changes suggest responses could be limited. 20

18 Opposition to SALT repeal 21

19 Other important tax changes for states States piggyback on federal individual income and corporate income tax any change to federal tax base affects states Lowering pass-through rate could push more taxpayers to file as partnerships, sole proprietorships Subsidy for municipal debt (with lower tax rates) this tax differential falls Increasing the standard deduction - Will also lower support for itemized deductions - Could increase income base Eliminate estate tax Cutting capital gains tax base in half (House GOP plan) 22

20 Could reform increase state tax revenue? House GOP plan eliminates all itemized deductions other than MID and charity 2016 Trump plan s cap on deductions could have similar effect Treating carried interest as ordinary income If more capital gain realizations this increases base for state income taxes 23

21 What about taxes related to the ACA????? Currently all taxes remain Not part of tax reform proposals Who knows 24

22 State Preparation in Response

23 Limited explicit Trump-inspired state action New York: If federal support is reduced by $850 million or more, the New York State Director of the Budget develops plan to make uniform spending reductions. Plan takes effect automatically unless the legislature passes their own plan within 90 days. Maryland: Supports Planned Parenthood if federal funds removed (over governor veto). 26

24 But States getting fiscal houses in order Improving Structural Budget Balance Rainy Day Fund Increases Cutting Spending Raising Taxes Kansas, Illinois: Legislative supermajorities override governors tax increases Oklahoma: Stopped income tax cut (trigger) and raised other fees (e.g., cigarettes) Gas tax hikes: CA, IN, MT, SC, TN, WV New marijuana taxes: CA, MA, ME, NV (via 2016 ballot initiatives) 27

25 In billions STATES CONTINUE TO STRENGTHEN RAINY DAY FUNDS 27 STATES ESTIMATED INCREASES IN FISCAL 2017; 28 STATES PROJECT INCREASES FOR FISCAL 2018 Rainy Day Fund Balances, Fiscal 2008 to Fiscal 2018 $60 $50 $40 $30 $20 $10 $0 $32.9 $29.0 $23.0 $34.3 $24.7 $21.0 $13.8 $12.3 $6.7 $3.0 $51.9 $51.9 $47.7 $47.8 $41.3 $35.1 $34.6 $28.9 $25.4 $18.8 $ * 2018* Total Excluding AK & TX $38.5 *FY2017 and FY2018 are estimates. Source: NASBO Spring 2017 Fiscal

26 Percent of General Fund Spending STATES CONTINUE TO STRENGTHEN RAINY DAY FUNDS SINCE HITTING RECENT LOW IN FISCAL Median Rainy Day Fund Balance as % of Expenditures 7% 6% 5.5% 6.0% 5% 4% 3% 4.6% 4.9% 2% 1% 0% 0.7% 2.0% Fiscal Year Source: NASBO

27 But Some Tax Cuts Delaware: Eliminated estate tax, but raised other taxes Maine: Budget eliminated high-income surcharge Add/expand EITC: CA, HI, MT, SC Generally waiting to see what happens next And not clear anything will get passed 30

28 Tax Reform is Hard Although cutting rates (and calling it reform) is easy 32

29 THANK YOU For more information please contact:

30 Distribution of Tax Change in House GOP Plan, 2017 Expanded cash income percentile b,c Percent change in after-tax income (%) d Share of total federal tax change (%) Average federal tax change ($) Average Federal Tax Rate e Change (% points) Under the proposal (%) Lowest quintile Second quintile Middle quintile Fourth quintile Top quintile , All , Addendum , Top 1 percent , Top 0.1 percent ,262,

31 Distribution of Tax Change in Trump Campaign Plan 2017 Expanded cash income percentile b,c Percent change in after-tax income (%) d Share of total federal tax change (%) Average federal tax change ($) Average Federal Tax Rate e Change (% points) Under the proposal (%) Lowest quintile Second quintile Middle quintile , Fourth quintile , Top quintile , All , Addendum , , , Top 1 percent , Top 0.1 percent ,066,

32 Revenue Effect of House GOP Proposal in Billions of Dollars Provision Individual income and payroll taxes Repeal ACA taxes ,430 Repeal alternative minimum tax Cut tax rates to 12/25/33-1,543-2,620 Repeal itemized deductions (other than charitable and mortgage interest) and Pease 1,908 3,342 Increase std. ded. To $24/$18/$12K -1,361-1, percent inclusion rate for capital income Top rate of 25 percent on active business income Repeal personal exemptions for taxpayer and dependents 1,654 2,428 Add. Non-ref. credit per dependent + increased CTC phaseout Repeal child and dependent care and elderly credits Expensing (with no interest deduction) Repeal some individual tax expenditures Total for individual income and payroll taxes -2,023-1,

33 Revenue Effect of House GOP Proposal (Continued) Provision Corporate income tax Reduce corporate rate to 20% and repeal the corporate AMT -1,845-2,751 Expensing (with no interest deduction) Territorial system for foreign-source income earned in Repatriation of untaxed foreign income Border adjustments 1,180 1,689 Repeal certain corporate tax expenditures Total for corporate income tax revenues Estate and gift taxes Repeal estate tax, enact carryover basis Total revenue effect of all provisions Total revenue change(static) -3,101-2,226 Total revenue change (dynamic) -3,037-3,

34 Revenue Effect of Trump Campaign Proposal in Billions of Dollars Provision Individual income and payroll taxes Repeal net investment income tax Repeal alternative minimum tax Repeal head of household filing status Repeal personal exemptions 2,000 2,871 Cut tax rates to 12/25/33-1,490-2,513 Increase std. ded. to $15/30K -1,688-2,264 Cap itemized deductions 559 1,021 Childcare provisions % pass-through tax rate ,423 Income shifting from 15% rate ,915 Expensing (with no interest deduction) Tax carried interests at ordinary rates Repeal some business tax expenditures Total for individual income and payroll taxes -3,343-5,

35 Revenue Effect of Trump Proposal (Continued) Provision Corporate income tax Reduce rate to 15%, repeal corp. AMT -2,355-3,514 Expensing (with no interest deduction) Repatriation of untaxed foreign income Repeal certain corporate tax expenditures Total for corporate income tax revenues -2,633-3,231 Estate and gift taxes Repeal estate tax, tax gains at death Total revenue effect of all provisions Total revenue change(static) -6,150-8,941 Total revenue change (dynamic) -5,972-10,