State Tax Cuts Revenue Implications: Analysis
With state taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.
revenues receding from all-time highs, there’s been a great deal of handwringing about whether states can afford the tax cuts adopted over the past few years. Curiously, there’s been no similar interrogation of whether states can afford the monumental spending increases adopted in that timeframe. Still, the question deserves to be answered: with 27 states reducing the rate of a major tax between 2021 and 2023, is there cause for concern?
Fortunately, this question can be addressed empirically, and the data strongly suggest that the answer is no.
Tax revenues remain substantially above pre-pandemic totals, even adjusting for high rates of inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power.
. And notably, tax revenues have risen more in states that cut taxes than those that haven’t. The 27 states that cut the rate of a major tax (individual income, corporate income, or sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding.
) experienced a 9.8 percent tax revenue increase in real terms between calendar years 2019 and 2023, while states that didn’t cut any of these taxes—or, in a few cases, increased them—saw tax revenues grow by 6.2 percent.
Think about what this means. The tax-cutting states grew revenue faster with lower rates.
We shouldn’t take this too far, naively asserting that tax cuts paid for themselves. But we should also acknowledge that states that have prioritized tax competitiveness have done better than their status quo peers.
With revenues soaring in recent years, state lawmakers have selected among three options: (1) increase spending, (2) cut taxes, or (3) both. With state general fund budgets up 21 percent in real terms between FY 2019 and FY 2024, there’s little question that expenditure increases have been popular in red and blue states alike. The real decision, therefore, has largely been between applying all of the increased revenue toward spending increases, on the one hand, or increasing expenditures but returning some of the revenue gains to taxpayers, on the other.
This shows up in the numbers. States that have not cut rates of a major tax since 2021 have grown their budgets by 24.0 percent in real terms, while states that have cut taxes have grown their budgets by 15.1 percent. In other words, most tax-cutting states have cut taxes out of a portion of revenue growth while still increasing government spending (albeit at a slower clip), not through spending reductions.
And while most states have taken steps to shore up their revenue reserves as well, in virtually every state, the money coming in is going back out again. The question is merely whether, and to what degree, that comes in the form of higher spending or tax cuts. In the event of a recessionA recession is a significant and sustained decline in the economy. Typically, a recession lasts longer than six months, but recovery from a recession can take a few years.
, states that used recent revenue gains exclusively to grow their budgets won’t somehow find themselves with more flexibility. If anything, states that have prioritized greater economic competitiveness through tax reform and relief may find themselves in a better position to weather a downturn.
State tax revenues have been on the rise in recent years for a variety of reasons. The Tax Cuts and Jobs Act (TCJA) broadened tax bases (which flowed through to state tax codes) and increased domestic investment. The Wayfair decision expanded states’ ability to tax remote sales at a fortuitous moment. Broad economic changes in recent years have generally yielded higher taxation. Inflation, unfortunately and unfairly, has increased taxability in real (not just nominal) terms. And, temporarily, federal pandemic relief boosted state tax revenues indirectly, by subsidizing individuals and businesses who then engaged in taxable activity. With pandemic relief in the rearview mirror and inflation leveling off, it’s no surprise that state tax revenues have receded somewhat from their all-time highs, nor should it be cause for concern. Calendar year 2023 revenues were lower than 2022’s, but still dramatically higher (accounting for inflation) than 2019’s. The trajectory remains good, as do the fundamentals, since the broader economic and policy forces at play remain unchanged.
What’s more, the reversion has been smaller in tax-cutting states than their status quo peers. In 2023, tax revenues in tax-cutting states receded 4.9 percent from their all-time highs (remaining 9.8 percent higher than pre-pandemic), while revenues in states that did not cut taxes slid 8.8 percent.
Concern about the 27 states that cut taxes between 2021 and 2023, therefore, seems misplaced. This doesn’t mean, of course, that all tax cuts are prudent, or that states can’t go too far. The Tax Foundation cautioned against excessive, unbalanced tax-cutting proposals in Mississippi and West Virginia, for instance, and helped lawmakers land on more responsible plans. But pundits shouldn’t worry about tax-cutting Georgia, Idaho, North Carolina, or Utah. They’re doing just fine. If only things were so sunny in tax-hiking California.
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