The past two years have been a good time to formulate national tax policies. Explosive revenue collection, coupled with hundreds of billions of dollars in pandemic related assistance from Congress, has removed difficult budget decisions from the agenda in most states.
In fact, 29 states passed massive tax cuts in 2021, and 35 states passed them in 2022, although most states have significantly increased spending and increased additional emergency funding. However, policymakers still face trade-offs when cutting taxes during abnormal fiscal periods.
In a new report, we analyzed five states – Connecticut, Delaware, Mississippi, Utah, and Vermont – to cut individual income tax rates, expand tax credits, or submit one-time discounts in 2022. We conducted a study of each state using the Center’s national income tax model and tax policies.
When some states consider cutting taxes again in 2023, the following are three lessons for 2022.
Tax cuts benefit families with more taxable income.
In all 11 states that cut the personal income tax rate in 2022, the families with the highest incomes will receive the largest direct benefits. This is because the benefits of tax cuts are related to household tax receipts. This happens, for example, when Mississippi sets a fixed tax rate and reduces the tax rate from 5% to 4%. (This reduction is expected to last for three years, but we have modeled it as if it would take effect immediately to simplify interstate comparisons in the report).
In other words, Mississippi households earning more than $100000 have an average annual tax cut of thousands of dollars because they pay tens of thousands of dollars in state income tax each year. (Note: The analysis unit is a tax unit; for simplicity, we use the term “family” in this article).
In contrast, households that pay little or no income tax will have little or no benefit from interest rate cuts. This group mainly includes low-income families, but may also include retirees. For example, about a fifth of households in Mississippi with an adjusted gross income of between $50000 and $75000 did not benefit from the tax cuts, most likely because they received social security benefits, pensions, and other taxable retirement income. Mississippi is tax exempt.
If the goal of policymakers is to promote economic growth, then cutting interest rates may help, although the calculation of tax growth is much more complex. But the interest rate cut itself does not help working families much. To do this, a state must create or expand refundable tax credits.
Target tax reduction to create target benefits.
Connecticut has expanded its Income Tax Credit (EITC), while Vermont has created a Child Tax Credit (CTC) for low-income families with children under the age of 6. Because both of these credits are repayable, they benefit households with little or no taxable income.
In 2022, 10 states created or expanded EITC or CTC. Although benefits and eligibility rules vary, each state has significant tax breaks for specific families, mainly low-income families with children, while limiting the cost of income. However, this also means that many families do not have any benefits.
For example, although the average annual tax reduction for eligible CTC households in Vermont exceeds $1000, only one in ten households with incomes below $100000 qualify. Similarly, although state EITC (based on federal eligibility rules) is more common and can reduce taxes by hundreds of dollars for working families, it benefits only about a quarter to one-third of low-income families.
In contrast, Delaware provides one-time tax breaks to all filers, while Mississippi and Utah tax breaks benefit more families.
The good times won’t last forever, but your tax cuts can.
Delaware approved massive tax cuts in 2022. The cost is approximately $220 million, equivalent to 4% of its General Fund income in fiscal year 2022. However, as this is a one-time discount, it will not affect future budget decisions. Name the tax cuts you want, but Delaware and 17 other states submitted tax cuts in 2022, which are consistent with possible one-time tax cuts.
At the same time, Mississippi’s tax cuts are both large and permanent (accounting for 7% of joint fund revenue in fiscal year 2022). “A reduction in income tax rates may not necessarily result in a relatively small loss of income in Utah, but overall, new or expanded tax credits, such as those in Connecticut and Vermont,”, The cost is far below the tax cut.
Although concerns about the economic downturn remain, when policymakers meet in state capitals to formulate new budgets, the state’s finances remain largely strong. Therefore, States that reduced their income tax rates in 2021 or 2022 may consider repaying credits to help families that did not benefit from previous tax cuts, while states that have approved one-time tax cuts may consider responsible permanent tax cuts Financial responsibility.
But at some point, perhaps soon, the economy will shift, and states that have already passed larger, long-term tax cuts will face more difficult fiscal choices because of these tax cuts. If this happens, they should remember which taxes they have cut and who they benefit from in this new budget environment.