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More Good News on State Taxes

In past TaxBytes articles such as this one, I have chronicled the fact that many state governments have been cutting marginal tax rates on individual income. 

The tax situation at the federal level is likely to be dismal, because neither party, but especially the Democratic Party, has much of a taste for reining in federal spending. That’s another story that I’ll tell in a future article. 

But the tax situation at the state level is much more hopeful. Most states have some form of a balanced-budget requirement, and state governments can’t print money. State governments, therefore, must live within their means. You might think that would cause them not to cut tax rates. But many state politicians have learned that by cutting tax rates they don’t necessarily cut tax revenues because those lower tax rates attract people from high-tax states. That leads to more income being taxed, thus dampening the revenue-reducing effects of cuts in tax rates. 

Here's Jared Walczak of the Tax Foundation in an article on that foundation’s site earlier this month: 

In aggregate, the 12 states known to be considering income tax cuts this year—including eight that have already adopted reductions—are anticipating that this coming fiscal year’s tax revenues will be 9.1 percent higher (inflation-adjusted) than pre-pandemic collections. Some, like Utah (32.3 percent), Idaho (24.2 percent), and Arkansas (18.7 percent), are looking at particularly dramatic gains. And if anything, FY 2025 could be better. Some of these states have not yet published their FY 2025 forecasts, but among those that do, the anticipated real tax revenue growth since before the pandemic is 11 percent.

State governments facing such huge growth in revenues can choose to spend more, cut tax rates, or some combination of the two. Governments in states with Republican governors tend to choose much more of the first. Walczak writes: 

No wonder income tax relief is on the table in Arkansas, Georgia, Idaho, Indiana, Kansas, Kentucky, North Dakota, Oklahoma, Utah, Virginia, West Virginia, Wisconsin, and potentially elsewhere.

Also, as state governments cut tax rates, they are moving closer to a flat income tax rate. Thirteen states—Arizona, Colorado, Idaho, Illinois, Indiana, Kentucky, Michigan, Mississippi, New Hampshire, North Carolina, Pennsylvania, Utah and Washington—already have a flat rate. In New Hampshire that rate applies only to interest and dividends and in Washington only to capital gains. 

And seven states—Alaska, Florida, Nevada, South Dakota, Tennessee, Texas and Wyoming—have a zero income tax rate. You can’t get flatter than zero. In total, therefore, 20 states have a flat income tax rate. 

Do California Governor Gavin Newsom and New York Governor Kathy Hochul, both from states with high “progressive” income tax structures, hear the footsteps of highly taxed people leaving? As a Californian, I sincerely hope so.