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State and Local Governments Face Six Significant Issues with the Trump Tax Cut Outline April 2017

State and Local Governments Face Six Significant Issues with the Trump Tax Cut Outline

Don Boyd, Lucy Dadayan, Tom Gais, and Jim Malatras, Rockefeller Institute of Government



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This week, the Trump administration made a big splash finally rolling out their tax cut outline. Their proposed massive tax cut would have significant impacts on state and local governments. There hasn't been anything with impacts this large for state and local governments since President Ronald Reagan’s 1986 Tax Reform Act.

Details are emerging, and more in-depth analysis must be done, but there are at least six issues that will affect state and local governments.

First, the elimination of the deduction for state and local taxes is a huge issue for states, like California and New York, that rely heavily on income taxes, and for local governments that depend on property taxes. Taxpayers in these states may consider the elimination of the deduction to be a form of double taxation, while opponents of the deduction may view it as an unjustified “subsidy” of state and local governments. Overlaying this philosophical debate is a political one: Many of the states whose residents would be most affected by ending the deduction are “blue” states, ones that did not support the president in the last election.

Then there are a host of empirical questions. The Alternative Minimum Tax (AMT) disallows the state and local tax deduction, and it has affected a growing proportion of taxpayers, but it is unclear how much the AMT has already eroded the deduction.

Also, the central argument about the effects of the elimination of the deduction involves assumptions about taxpayers demanding changes in state and local tax policy; that is, state and local residents would be much less supportive of state and local taxes if they can no longer deduct them on their federal forms. The elimination of the deduction may fuel a taxpayer revolt and lower high state and local taxes in these states. However, given the political complexity in these states (e.g. public schools and other politically important programs are funded by state and local taxes), it is also possible that nothing would change and these taxpayers would simply face significantly higher costs.

Second, even if the Trump outline is not enacted, is delayed, or significantly modified, taxpayers may change their behavior in anticipation of legislation. They may defer income, accelerate deductions, or re-characterize and alter the composition of income — potentially exerting profound impacts on state tax revenue. This is something the Rockefeller Institute of Government stressed in a November 2016 Fiscal Report. It will be imperative that states try to understand and estimate these potential impacts, and then buckle up for a wild ride.

Third, there are many implications for the spending side of the federal budget, many of which would have impacts on state and local governments. State and local governments directly received about 22 percent of their total revenues from the federal government in 2014 — and their populations were benefited in many other ways by federally funded programs. An unfunded tax cut of this size could put enormous pressure on such expenditures, particularly in the context of other dramatic changes being proposed that could put additional fiscal constraints and uncertainty on state and local governments, like repealing and replacing the Affordable Care Act. Already, states are struggling with lower projected and actual state tax revenues. The proposed Trump tax outline muddies this already murky revenue picture.

Fourth, it is hard to gauge the economic effects of the Trump tax outline. Although the Trump administration believes it will spur economic activity, and they claim that the additional economic growth will pay for the multi-trillion-dollar federal revenue loss, there is no historical precedent for such an effect. Also, to the extent that the plan does have economic effects, those may differ from industry to industry, and such differences could have implications for different regions and states, though predicting the effects for particular states will be extremely difficult.

Fifth, a dramatic overhaul like this at the federal level will put a tremendous amount of pressure on states that have income and corporate taxes to make conforming and other changes to their own tax systems. Having states open their tax codes, in this highly contentious political environment and with such long delays, creates enormous uncertainty for state and local governments.

Sixth, the federal tax cut program is being proposed at the most critical time of the year for the state governments, as they are in the midst of finalizing (or have already just finalized) their state budgets for FY 2018. This creates even greater fiscal uncertainty (uncertainty started by the Trump pre-election proposals) — thus potentially producing a highly chaotic fiscal environment for the states.

State and local governments face these six issues with the Trump tax cut outline. But now we need details to fully understand the effects of the outline.


ABOUT THE ROCKEFELLER INSTITUTE OF GOVERNMENT

The Nelson A. Rockefeller Institute of Government, the public policy research arm of the State University of New York, conducts fiscal and programmatic research on American state and local governments. It works closely with federal, state, and local government agencies nationally and in New York, and draws on the State University’s rich intellectual resources and on networks of public policy academic experts throughout the country.