These states may soon slash their residents' income taxes
The pandemic was expected to decimate state tax revenue as millions lost their jobs, but two years after the start of the crisis, many states are instead flush with cash. That's prompting more than a dozen states to propose a new strategy: cutting income taxes for residents.
Some of the states have recently passed a reduction in their income tax rates, such as in Idaho, where its governor in February signed into law a cut that will save residents anywhere from hundreds to thousands each year, depending on their earnings. Other state lawmakers are currently hammering out the details, which means the tax cuts aren't yet certain.
Across the country, state and local government tax revenue jumped 42% in the second quarter of 2021 compared with the same period a year earlier, according to a December analysis from the Urban Institute. Taxes have been bolstered by the economic recovery from the pandemic, with corporate taxes rebounding. Workers have regained jobs, helping to boost income taxes. And consumers are spending more, helping to bolster sales tax revenue.
Governors and state lawmakers say they want to return some of that windfall to residents, especially at a time when inflation is making it pricier to pay for everything from groceries to gasoline. But there's another reason that states are pushing for lower taxes: some lawmakers believe it will make their locales more attractive to higher-paid white-collar workers who are seeking to relocate amid the pandemic's shift to remote work.
"Inflation has definitely been a big part of the discussion this year, and I think that's why we are seeing a bipartisan interest in tax relief," said Katherine Loughead, a senior policy analyst at the Tax Foundation who has been following the proposals.
She added, "We're seeing a lot more states are talking about phasing out individual income taxes — they are seeing how no-income tax states are gathering a lot of residents," such as Florida and Texas.
Some policy experts and lawmakers in Georgia and Wisconsin, for instance, have floated the idea of eliminating their states' income taxes entirely. Currently, there are nine states that don't tax wages, ranging from Florida to New Hampshire.
States that are eyeing income tax reductions tend to be led by Republicans, but more widespread proposals to cut taxes through lower groceries or gasoline tariffs are popping up in both Democratic and Republican-led states. For instance, both the Republican governor of Georgia and Democratic governor of California called for relief from state gas taxes in March due to the spike in fuel prices.
Will tax cuts increase inflation?
There are plenty of questions facing states as they propose slashing taxes. Lower tax rates will give consumers more money in their pockets — but it risks lowering state revenue, which could be a dicey proposition if those coffers don't stay full for long.
And it could also push inflation higher if consumers turn around and spend the money, pushing up demand for goods at a time when the supply chain is already constrained, warned Howard Gleckman of the Urban Institute's Tax Policy Center, a non-partisan think tank.
Lowering taxes "will drive up prices and worsen the inflation that the governors claim to be so worried about," Gleckman wrote in a March 15 blog post. "And it will increase pressure on the Federal Reserve to raise interest rates even more than it planned."
Below are states that in 2022 are proposing or have recently approved cuts to their income tax rates.
Colorado
A Republican-sponsored bill would cut the state income tax rate to 4.4% from 4.55%.
A non-partisan analysis of the proposal noted that it would have little or no impact on low-income taxpayers who don't have tax liabilities. While the average tax cut would be $100 per year, the biggest benefits would largely be enjoyed by higher-income taxpayers. For instance, households earning more than $200,000 a year would save about $600 in taxes.
Georgia
Georgia's House recently approved a bill that would create a flat state income tax with a 5.25% rate, raise the amount of income exempt from taxation and eliminate many deductions. Georgia's top income tax rate is now 5.75%, which applies to income over $7,000 earned by a single person or income over $10,000 earned by a married couple or single person with dependents.
About 62% of the flat-rate benefits would flow to the top 20% of Georgia tax filers, according to an analysis by the liberal-leaning Georgia Budget & Policy Institute, using modeling by the Institute on Taxation and Economic Policy.
Some lawmakers want the state to cut taxes even further, with two Republicans proposing to entirely abolish the state income tax — which currently provides roughly half of Georgia's nearly $30 billion in state revenue. One of the GOP lawmakers said he wants to eliminate the tax because "taxation is theft."
Idaho
The governor of Idaho, Republican Brad Little, in February signed a bill that represents the state's largest tax cut, according to the Idaho Capital Sun.
The new law condenses the state's five tax brackets to four, and cuts the income tax rate on the wealthiest tax bracket to 6% from 6.5% — an effort that will reward the wealthiest Idahoans, according to the Idaho Center for Fiscal Policy.
Households earning more than $557,000, or the top 1% in the state, will reduce their taxes by more than $13,000 annually. By comparison, middle-class households earning between $44,000 to $71,000 will see savings of less than $300 a year.
The law also includes $350 million in tax rebates, which will apply to 12% of an individual's 2020 Idaho income tax return, or $75 for each taxpayer and dependent, whichever is the greater amount.
As Little said when he signed the bill: "I remember my mother telling me you can't have your cake and eat it too, but we kind of are this year."
Indiana
State lawmakers passed a $1.1 billion tax cut package earlier in March. The bill slices the individual income tax rate to 2.9% from 3.23%, which would save about $100 per year for an Indiana resident earning about $30,000 a year, according to the Indianapolis Star.
The bill also eliminates the tax on utilities of 1.4%, which will save homeowners about $4 or $5 a month, the Star said.
Iowa
On March 1, Iowa's governor signed a bill to introduce a flat tax of 3.9% in 2026, instead of its current graduated tax rates that go as high as 8.5%.
The bill also eliminates state tax on retirement income starting in 2023, which will apply to IRA distributions, taxable pensions and annuities.
Michigan
Lawmakers in Michigan recently reached a deal to slash the state's income tax rate and create new tax credits for retirees, according to the Detroit Free Press.
The plan would cut the personal income tax rate to 3.9% from 4.25%, and doubles the retirement tax deductions to $40,000 for individuals and $80,000 for couples for people born after 1945.
But its fate is in doubt as Gov. Gretchen Whitmer, a Democrat, has called the plan "fiscally irresponsible," the Detroit News reported.
Mississippi
Lawmakers in Mississippi are proposing to reduce income taxes by phasing out one tax bracket, which currently assesses a 4% tax on earnings between $5,000 to $10,000. The bill would also reduce the sales tax on groceries to 5% from 7% starting in July, according to the Clarion Ledger.
But other lawmakers in the state want to eliminate its income tax entirely — with the idea of drawing more people to the state and kickstarting the economy, the Commercial Appeal reports. Others oppose the tax cuts, saying that Mississippi can't afford the challenging cuts in government services they would cause.
"We are not paying state employees, our roads are crumbling. We have not funded the schools," state Sen. Hob Bryan, a Democrat, told Mississippi Today. "We don't have water and sewer. We can cut taxes and not have a functioning society. That is where we are heading now."
Missouri
Missouri Gov. Mike Parson, a Republican, is proposing cutting the state's income tax rate to 5.3% from 5.4%. Some lawmakers want to cut taxes even deeper, with Republican state Sen. Lincoln Hough proposing a tax cut to 4.8%.
"Missouri should be returning the people's money," Hough said, according to the Missouri Times. "It's their money and they should get to decide what's best for themselves and their families."
Nebraska
Nebraska lawmakers last month approved personal and corporate income tax cuts backed by Republican Gov. Pete Ricketts, despite reservations about who would benefit the most and the likely revenue losses for the state.
The Nebraska proposal would lower the top individual income tax rate to 5.84% from 6.84% by January 2025. The top corporate income tax rate would drop to 5.84% from 7.5%.
New York
Gov. Kathy Hochul is proposing tax relief for New Yorkers through a $1 billion property-tax rebate program.
The Democrat also wants to accelerate planned income tax cuts to 2023, instead of 2025. For instance, she would push forward a rate reduction to 5.5% on households earning between about $81,000 and $215,000, down from the current rate of 6.33%.
The average benefit of the property tax rebate would be about $970 for homeowners outside of New York City, according to Bloomberg News.
Oklahoma
Gov. Kevin Stitt, a Republican, in February proposed a "taxpayer protection plan" that would lower income taxes based on the state's revenue. He also called for exempting military benefits from state income taxes and getting rid of the state sales tax on groceries.
Those cuts would come after the state lowered its tax rates this past January 1, with individual income tax rates reduced by 0.25%.
South Carolina
In February, Gov. Henry McMaster, a Republican, proposed immediately lowering the tax rates for residents, cutting the rates for the current 4%, 5% and 6% tax brackets to 3% and to trim the current 7% bracket to 6.5%.
The proposal is currently being hammered out by lawmakers, with some tweaks potentially in the works, according to local CBS station WLTX. For instance, under one plan, the 7% bracket would be reduced to 5.7%. Under the various proposals, a person earning about $58,000 could save between $400 to $560 a year, WLTX said.
Residents who file a 2021 tax return in the state will also get a one-time rebate of between $100 to $700 by year-end, WLTX noted.
Utah
Lawmakers in Utah in February approved an income tax reduction that trims the state's rate to 4.85% from 4.95%. More than 1 million taxpayers would save an average of $129 each in income taxes.
—The Associated Press contributed to this report.
