- State tax changes are not made in a vacuum. States often adopt policies after watching peers address similar issues. Several notable trends in tax policy have emerged across states in recent years, and policymakers can benefit from taking note of these developments.
- The enactment of the federal Tax Cuts and Jobs Act (TCJA) expanded many states’ tax bases and drove deliberations on tax conformity. At year’s end, only five states conform to an older version of the federal tax code, though many have yet to resolve issues raised by their tax conformity regimes.
- Several states experimented with mechanisms to allow their high-income taxpayers to avoid the new cap on the state and local tax (SALT) deduction, efforts cast into doubt–though not entirely ended–by draft U.S. Treasury regulations.
- Three states and the District of Columbia cut corporate taxes in 2018, with rate reductions pending in two other states. Reductions in other taxes on capital are ongoing as well, with Mississippi beginning the phaseout of its capital stock tax.
- The U.S. Supreme Court’s Wayfair v. South Dakota decision ushered in a new era of sales taxes on e-commerce and other remote sales, but many states have yet to implement the provisions the Court strongly suggested would protect such tax regimes from future legal challenges.
- A second state (Arizona) adopted a constitutional amendment banning the expansion of the sales tax to additional services, with similar efforts–which have the effect of locking an outdated sales tax base in place–expected to emerge in other states in 2019 and beyond.
- A court ruling has states scrambling to legalize and tax sports betting, while shifting public attitudes continue to render the legalization and taxation of marijuana an attractive revenue option in a growing number of states. In 2018, seven states adopted sports betting taxes, while two legalized and taxed marijuana.
- States continue to grapple with the appropriate taxation, if any, of e-cigarettes, with two states adopting taxes at rates reflective of vapor products’ potential for harm reduction, while the District of Columbia increased its tax to a punitive 96 percent rate.
- Business head taxes came out of nowhere to become a key consideration for several cities, particularly those with thriving tech sectors.
- Consideration of gross receipts taxes continue as corporate income tax revenues decline, though concerns about their economic effects have generally helped stave off their adoption.
- Two states repealed their estate taxes in 2018, continuing a decade-long trend away from taxes on estates and inheritances.
- Revenue triggers, a relatively modern innovation, again featured prominently in tax reform packages and will continue to do so.
State tax policy decisions are not made in isolation. Changes in federal law, global markets, and other exogenous factors create a similar set of opportunities and challenges across states. The challenges faced by one state often bedevil others as well, and the proposals percolating in one state capitol often show up elsewhere. Ideas spread and policies can build their own momentum. Sometimes a trend emerges because one state consciously follows another, and in other cases, similar conditions result in multiple states trying to solve the same problem independently.
Identifying state tax trends serves a dual purpose: first, as a leading indicator providing a sense of what we can expect in the coming months and years, and second, as a set of case studies, placing ideas into greater circulation and allowing empirical consideration of what has and has not worked.
The adoption of the federal Tax Cuts and Jobs Act (TCJA) and the U.S. Supreme Court’s decision in Wayfair v. South Dakota set off a chain reaction in state capitals, and the reaction to a Court decision on sports betting has been swift and enthusiastic in a growing number of states. As policymakers grapple with tax conformity under the TCJA, seek to craft Wayfair-compliant remote sales tax regimes, and figure out if and how to legalize and tax sports betting, they can and should learn from their peers.
Some trends worth noting have been with us for years, while others are just emerging; some are promising, while others might be thought of as cautionary; and some are time-constrained reactions to exogenous factors, while others represent innovations other states may wish to adopt. In all cases, policymakers can benefit from greater awareness of these developments.
Across the country, income tax policies–both individual and corporate–were heavily influenced by the enactment of federal tax reform. States grappled with how to conform to the provisions of the new tax law, and in some cases sought to help their taxpayers circumvent its effects. The past year also saw further corporate income tax rate reductions and the adoption of reforms intended to enhance the neutrality of individual income tax codes.
IRC Conformity Updates
Most states begin their own income tax calculations with federal definitions of adjusted gross income (AGI) or taxable income, and they frequently incorporate many federal tax provisions into their own codes. The degree to which state tax provisions conform to the federal Internal Revenue Code (IRC) varies, as does the version of that code to which they conform. Some states have “rolling conformity,” meaning that they couple to the current version of the IRC, while others have “static conformity,” utilizing the IRC as it existed at some fixed date. Although exceptions exist, most states with static conformity update their conformity date every year as a matter of course.
The adoption of the Tax Cuts and Jobs Act (TCJA) turned what had been routine into a serious policy deliberation. Most states stand to see increased revenue due to federal tax reform, with expansions of the tax base reflected in state tax systems, while corresponding rate reductions fail to flow down. The increase in the standard deduction, the repeal of the personal exemption, the creation of a deduction for qualified pass-through business income, the narrowing of the interest deduction, the cap on the state and local tax deduction (which affects state deductions for local property taxes), adjustments to the treatment of net operating losses, and enhanced cost recovery for machinery and equipment purchases, and even some of the provisions on the taxation of international income, flow through to the tax codes of some states—in different combinations, depending on the federal code sections to which they are coupled.
States, therefore, were faced with choices. They could continue to conform to an older version of the IRC to avoid these revenue implications. Alternatively, if conforming to the IRC post-TCJA, they could decouple from revenue-raising provisions, cut tax rates or implement other tax reforms to offset revenue increases, or do nothing, keeping the additional revenue.
The extent to which this is true (and indeed in some cases, whether it is true) depends on the federal tax provisions to which a state conforms. In 2018, five states–Georgia, Iowa, Missouri, Utah, and Vermont–adopted rate cuts or other reforms designed, at least in part, as a response to the expectation of increased revenue due to federal tax reform. Others, like Maryland and New York, rolled back some–but not all–of the federal changes to reduce the added state tax burden. States have generally been more willing to roll back changes to the individual income tax than to the corporate income tax. Finally, other states have been satisfied to retain the additional revenue, at least for now.
As of December 15, 2018, 32 states and the District of Columbia…