The United States is in the midst of a tax-cutting frenzy as both red and blue states have suddenly found themselves flush with cash. Governors and state lawmakers are eager to return some money to their constituents, a move well timed for the upcoming election. That they are in a position to do so is yet another sign of just how strong the economic recovery is — and how the federal government’s pandemic aid greatly exceeded what was needed for states.
Last year, 29 states and D.C. passed significant tax cuts, according to a tally from the Tax Policy Center. The most popular actions were to slash individual income tax rates and to expand a state’s earned income tax credit, which acts as a wage boost to low-paid workers. States are widely expected to cut even more this year. State budgeting season is just starting, but Idaho has already signed into law the largest tax cut in state history, with big reductions for individuals and businesses, and New Mexico has approved $250-per-person income tax rebates. Numerous governors are also trying to waive taxes on gas, groceries and other items.
These tax cuts are not coming from the $350 billion that went to state and local governments in the American Rescue Plan that Democrats passed last year. That money contains an explicit prohibition that it can’t be used for tax cuts (numerous GOP-led states are challenging that prohibition in court). Instead, states have seen big increases in tax revenue as their economies rebounded faster than expected, unemployment aid and stimulus payments kept incomes and taxes up, and Americans went on huge spending sprees that sent more sales tax dollars to state coffers. Additional aid for schools, health care and transit ensured state budgets didn’t have major holes. In total, state and local governments received $885 billion in direct funds from all the covid relief bills that Congress passed, plus the indirect benefit of more tax revenue triggered by other aid to households and businesses.
The result is states have more money than they seem to know what to do with. While President Biden and his team argued that it’s better to give too much relief than not enough, they overdid it on state aid. By a lot.
One-time rebates and expanded tax credits to encourage work and help struggling families are reasonable uses of these excess state funds. But many states want to go well beyond that. Mississippi is debating whether to eliminate its income tax entirely, an unwise move that mainly benefits the wealthy and is likely to jeopardize state funding in years to come. Florida’s governor wants a gas tax suspension in the coming months, and Illinois’s governor wants a one-year gas tax hike delay. Such moves make for great campaign ads, but consumers typically don’t get the full benefit since oil companies often hike prices in response.
A key lesson from this pandemic is just how unpredictable the future can be. Slashing taxes now, when state coffers are full, is easy. It won’t look nearly as wise if boom times don’t last.