Tax & Budgets
What Really Happened to State Revenues During COVID-19?
June 29, 2021 | Morgan Scarboro, Blaine Boles
This year’s state legislative sessions served as the culmination of a change we have been seeing for several years: Democrats are moving away from former President Clinton’s line that the “era of big government is over” and are becoming increasingly comfortable with pushing big, aggressive tax changes. Certain segments of the party have always been comfortable with the notion that certain groups (almost always the wealthy and large businesses) are not “paying their fair share”, but in recent years that belief has become an increasingly mainstream position.
This shift helps to explain why a number of blue states continued to push for tax hikes this year, despite states being “collectively awash in cash.” As the legislative season progressed and it became increasingly clear that state revenues were rebounding beyond expectations, the policy rationale for many of these tax proposals explicitly became that requiring targeted groups to pay more tax was inherently good.
The particulars of these legislative efforts varied and weren’t equally successful, but the efforts in these four states encapsulate the trend.
In an effort to fund landmark education reform during their 2020 legislative session, Maryland lawmakers debated a slate of bills (HB 732 & HB 932) that taxed digital advertising services and certain kinds of digital goods. Both bills were controversial, but the digital advertising proposal received particular criticism, with experts warning that legal challenges under the Internet Tax Freedom Act and the Commerce Clause would almost assuredly sink the tax, making it a risky funding mechanism.
Even three or four years ago, criticism of the underlying policy rationale and the threat of a powerful lawsuit would have been enough to deter legislative leaders from this course, but retirement of a few older, more moderate Democrats changed the political dynamics. These newer more progressive lawmakers were committed to bringing in more revenue to schools and were persuaded that a digital advertising tax would serve as a check on the power of social media companies.
The bills moved briskly through the process in 2020 until Governor Hogan’s (R) veto and COVID-19 halted their progress. While they may have been delayed, roughly a month after returning to Annapolis in 2021, the legislature voted to overturn the veto. A lawsuit challenging the legality of the digital advertising tax followed soon thereafter.
Unlike the other states on this list, Maryland’s tax proposals were paired with a specific spending goal, but the debate was also heavily influenced by a desire to have large technology companies pay more taxes (there were other, less jurisprudentially dicey taxes they could have pursued after all...and the ultimate economic incidence of the tax, if it survives, will fall broadly on businesses large and small).
Since the Independent Democratic Caucus dissolved in 2018, progressive lawmakers had been trying to consolidate their power in Albany and exert more influence over tax and spending policy. Governor Cuomo (D) famously has had a particularly tight grip over the state budget, often personally hammering out the final contours of the package with leaders of the Senate and Assembly. And while the governor came from a storied Democratic family, by the standards of Albany he often was a moderating force on fiscal issues.
Progressive members of the legislature saw their chance to exert more control when allegations of sexual harassment and mishandling of New York’s COVID-19 pandemic response rocked the governor’s office and threatened to end his governorship. While New York legislators always offer amendments to the budget policies first introduced by the governor, the 2021 amendments were a marked change.
Cuomo’s original budget proposal (AB 3009/SB 2509) levied a temporary personal income tax surtax on upper-income individuals and delayed the reduction of a series of middle-class tax cuts, and even that plan was expected to be scaled back once revenues rebounded and additional federal aid was forthcoming. Legislators, by contrast, called for permanent taxes on the wealthy, new taxes on non-corporate businesses, taxes on capital gains, a surtax on the telecommunications industry, and a corporate income tax rate hike.
The Democratic caucus had been angling for these ideas for years, but with Governor Cuomo weakened they had the leverage to make them law. The final budget didn’t include every tax proposal that progressives had called for, but it went much closer to their preferences than the governor’s. Governor Cuomo’s acquiescence is made all the more remarkable by the fact that the Wall Street Journal recently reported that the governor’s budget team knew in March that state revenues were running about $4 billion ahead of projections. So the government knew that the state was flush, but didn’t see that as a reason not to levy billions in new taxes.
Progressive lawmakers in the Connecticut General Assembly tried to run a similar playbook as their counterparts in New York, but a different political landscape yielded different results. Revenue projections had been steadily on the rise since February, but when the budget writers put together their tax bill (HB 6443) it included language to permanently extend the corporate business tax surcharge, levied a 2 percent consumption tax (really a tax on upper-income individuals), and a Maryland-style digital advertising tax, among many other tax changes.
Proponents of the bill argued that it was essential to raise taxes on those who had fared best during the pandemic in order to fund services to confront racial and economic inequality. As in New York, lawmakers weren’t pairing these new taxes with a marquee spending initiative, instead their argument boiled down to the need to redistribute money overall: the wealthy and businesses will pay more and existing social programs will get more.
Governor Lamont (D) was sympathetic to many of the legislature’s social goals and seemed open to some of its tax proposals, but overall he opposed broad-based tax increases in the budget. His office argued that “tinkering with taxes” coming out of a pandemic could negatively affect investment and job creation. Unlike Governor Cuomo, however, Governor Lamont was able to use his position as a fiscal moderate to his advantage, knowing that he could win points with his voters by running as the opponent of big, progressive tax hikes.
Budget negotiations between the governor and the legislature dragged on past the end of the regular session with tax hike proponents folding under the threat of veto. The final tax bill (SB 1202A) did include some new tax revenue, but it came in the form of temporary extensions of existing provisions.
While progressives weren’t successful this year, key lawmakers are already saying that they plan to bring these ideas back up if Connecticut faces a fiscal cliff when federal aid runs out in 2024.
Colorado’s reputation as a solidly blue state is a quite recent phenomenon, and Democratic actions in 2021 felt like a testing of their political strength. The state’s Taxpayer Bill of Rights (TABOR) makes levying new taxes a difficult and complicated process, so typically big proposals will be paired with a must-pass bill like the budget in order to get them over the finish line. So when the General Assembly passed their budget in May without any major revenue changes, it was assumed that lawmakers had opted not to pursue new taxes this year.
With less than a month left to go in the regular session, two significant tax bills popped up: HB 1311 & HB 1312 The bill’s sponsors were explicit that they wanted to levy taxes on wealthy individuals and businesses in order to promote “tax fairness.” The bills established new rules for combined corporate returns, created a list of so-called “tax haven” jurisdictions, created new property valuation standards, applied the sales tax to some digital goods, and eliminated the vendor compensation fee.
Governor Polis (D) often acts as fiscal moderate on tax policy and, like Governor Lamont, could have conceivably blocked the bills by saying that they were unnecessary given the state’s revenue climate. Instead, the governor endorsed the bills, saying that they would be a boon to struggling small businesses.
Despite all the traditional bulwarks against raising taxes in Colorado, Democrats were able to push through two major tax increases quickly and relatively easily with no more solid policy rationale than that it would make the system more fair. Although a TABOR challenge to the new laws may come, it’s not clear that TABOR will prevent these tax increases from sticking.
What we are seeing in all of these states is progressive legislators pushing to tax businesses and the rich, typically not to fund anything in particular, but in order to make the system more “equitable” by redistributing a greater share of income. There is a growing movement within elected Democrats that this is the direction that the party should be headed.
Federal funds are buoying state budgets this year, but if lawmakers choose to establish new, ongoing programs with these one-time funds then state governments will have to resolve the revenue imbalances in several years when the COVID-related federal funding ends. Such a fiscal cliff would create a political environment where aggressive tax changes are more politically palatable than this year when treasuries are flush. After all, if progressives were willing to push this hard for new taxes in a year when their state coffers were full, what will happen in a few years if deficits are more widespread?
Coming up next: a review of states that may indicate the future of tax policy in conservative states.
Tax policy can be one of the most challenging areas for government affairs executives. In the wake of significant changes in the economy and federal tax laws, state and local tax policy has become a top priority for large businesses and trade associations. MultiState’s team understands the issues, knows the key players, and can help you effectively navigate and engage. If you need help understanding how state tax changes will impact your organization, read more about our Tax Policy services, or contact us here.
June 29, 2021 | Morgan Scarboro, Blaine Boles
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