Trump tax law poised to create windfall for states

When President Trump signed a massive tax overhaul late last month, congressional Republicans celebrated a job accomplished. But the work is just starting for state legislators, who are likely to see hundreds of millions of dollars in new revenue. 

Under the new law, budget analysts say taxpayers who receive a break on their federal forms are actually likely to spend more on their state taxes, unless state legislators act. And that’s setting off contentious fights between those who want to use the money to boost state budgets and those who want to return money to the taxpayers.

“Now we get to do tax reform in all 50 states,” said Nicole Kaeding, an economist at the nonpartisan Tax Foundation.

{mosads}Most states conform parts of their tax codes — like definitions set by the IRS or deductions and tax credits for mortgages and children — to the federal code. But states set their own tax rates independently. The federal tax overhaul eliminates some deductions, broadening the tax base at both the state and federal levels.

“The tax revenue that we get in the state is dependent in some cases on the federal government,” said Joyce Peppin (R), the majority leader in the Minnesota House of Representatives.

That many means taxpayers could soon be on the hook for higher state tax bills.

The reform package “made the federal base of taxation broader, and it lowered the rates. The states couple to the base, but they set their rates independently,” Kaeding said. “Assuming their rates don’t change, which would be a proactive change, then states would have more revenue.”

The federal overhaul limits the amount of state and local taxes that filers can write off, potentially giving huge windfalls to some states. 

Maryland’s Bureau of Revenue estimated the state’s taxpayers would pay $450 million more in state taxes and $300 million more in local taxes every year under the new law. Gov. Larry Hogan (R) has said he will introduce legislation to give that money back to local taxpayers.

Colorado Gov. John Hickenlooper (D) has taken the opposite approach. He has asked his legislature to add $300 million in new spending, revenue that will come from the federal tax overhaul. 

Some states anticipate higher revenue for other reasons. In Iowa, one of six states that allow taxpayers to deduct their federal taxes from their state returns, the Department of Revenue estimated that the federal rate cuts would generate $138 million in new revenue. 

In Michigan, where tax filers can claim the same number of federal deductions on their state taxes, fewer federal deductions means taxpayers will pay more to state government. 

Other provisions of the tax overhaul will leave states guessing just how much money they can expect to take in. While things like the state and local deduction are easy to estimate, provisions like a cap on mortgage interest deductions are harder to calculate, Kaeding said. 

And for legislators who have to balance their state budgets every year, that uncertainty is unsettling. 

“Every time you have a change that you’re conforming to in the federal law, it’s somewhat a guess how much effect that’s going to have on your state revenues,” said Brent Hill (R), president of Idaho’s state Senate. “And when you’re guessing, you don’t have to be off very far to find yourself with a shortfall or an average you wish you hadn’t charged the taxpayer.” 

Earlier efforts to overhaul the federal tax code also left states fighting over how to handle the new windfalls. After the last major tax reform passed in 1986, most states cut taxes. Indiana stood out as an exception, using some of the new revenue to boost spending. 

This year, some states are likely to follow Hickenlooper’s lead in allocating at least some new money to state programs. Arizona legislators expect a fight between tax cutters and those who want to use some of the new revenue for school funding, for example. 

Others will do what Hogan will propose in Maryland, offering targeted cuts to give the unexpected windfall back to the taxpayer. 

“We need to make sure that we have everybody, across the board, seeing real, meaningful tax reductions,” said Robin Vos (R), the Speaker of the Wisconsin Assembly.