Much has been made of the GOP’s willingness to expand the deficit in the Tax Cuts and Jobs Act of 2017. But that’s not the only once-cherished Republican tenet abandoned in the tax proposal and other recent GOP initiatives.
This tax bill goes in the opposite direction. It is likely to make it harder for state and local governments to raise their own revenue. Here’s how.
How the tax bill could affect state fiscal policy
First, the bill reduces the federal estate tax. That will put pressure on the dozen states that have estate taxes to reduce theirs, as well, along with a handful that have an inheritance tax. In many of these states, the amount exempted from estate taxes is lower than the old federal exemption of $5.43 million per person and, certainly, lower than the new federal exemption, which has been doubled. There will be pressure to increase the state exemptions to the federal level, lowering states’ estate tax revenue.
Second, state income taxes on both individuals and businesses are typically linked to federal taxes. Many states emulate the definitions of income and deductions in the federal tax code, a practice called conformity. If federal taxable income declines, so will state taxable income in many states, unless states make adjustments. Conversely, if states continue to allow deductions that are eliminated at the federal level, taxable income — and state income taxes — will rise.
Thus, states potentially have some complicated decisions to make. Given Republican control of governorships in 34 states and a trifecta of GOP control of the executive and legislative branches in 26 states, many states will find it difficult to raise taxes when national Republicans have so recently championed tax reduction.
Third, the new tax bill no longer allows individuals to deduct all of their state and local taxes on their federal income tax returns; there’s a cap of $10,000. That will pressure high-tax states to lower their own taxes and, therefore, revenue. Before, unlimited deductibility meant that a taxpayer in the 35 percent tax bracket in the federal system with state and local taxes of $30,000 paid $19,500 after the deduction. But now she will pay $26,500, as the 35 percent break will apply only to the first $10,000 of state and local taxes. Some taxpayers will fall into a lower federal tax bracket in the new law, but they will still end up paying more state and local tax because of the cap. With high-income taxpayers now facing the fuller brunt of state and local taxation, there will be pressure to lower those taxes — and increased opposition to raising them.
As a result, state income taxes may become less progressive, too. The state and local tax deduction allows states to generate more revenue; many states do so with a progressive income tax. If states respond to the cap on the state and local tax deduction by lowering their top income tax rates, the GOP tax bill will reduce tax revenue and the share coming from wealthier people at both the federal and the state levels.
Republicans have challenged federalism in other ways
Of course, this is not the first example of a shifting Republican stance on federalism. George W. Bush’s No Child Left Behind law increased federal control over K-12 education, which had long been left to state and local governments.
Moreover, Republican-controlled state legislatures have been curtailing local governments’ authority. This preemption has a long history. In the 1970s, beginning with California’s Proposition 13, states began passing laws that limited local governments’ ability to raise and spend revenue. At the time, voters were frustrated by the combination of inflation and increasing property taxes. Today, 42 states have such limits in place.
But there has been a new round of such limits since 2011. Cities and towns have been passing laws increasing the local minimum wage, instituting paid sickness or family leave, and establishing municipal broadband networks. States have reacted with laws that override and nullify municipal actions.
According to the National League of Cities’ February 2017 report, 24 states now have laws preventing cities from passing minimum-wage ordinances. Seventeen states prevent paid-leave laws. Seventeen outlaw municipal broadband — high-speed Internet provision by a public entity or a public-private partnership rather than a private telecommunications company. Three outlaw local anti-discrimination ordinances; the Supreme Court’s 1996 Romer v. Evans decision bars preemption of the fundamental rights of protected classes of people but is less clear on economic rights. In nearly all these cases, Republican-led state legislatures are preventing Democratic-led cities from passing their own laws.
Of course, there is nothing that says states or localities always make the right decisions. See, for example, Jim Crow. And Democrats also run hot and cold when it comes to federalism.
But with this tax bill about to become law, it is important not only to assess its potential effect on federal tax revenue and on Americans’ federal tax burdens. It is also crucial to see how it could end up constraining state and local governments. States are already in a tight situation, with balanced-budget requirements and significant responsibilities for infrastructure, education and job training, and assistance for vulnerable populations. These responsibilities will be more difficult to fulfill if one “trickle-down” effect of the tax bill is to make it harder for states and localities to raise revenue.
Andrea Louise Campbell is Arthur and Ruth Sloan Professor of Political Science at MIT. She is the author of “Trapped in America’s Safety Net: One Family’s Journey” (University of Chicago Press, 2014) and is writing a book about public opinion and taxation in the United States.