Tax & Budgets
Big Tax Changes Coming? Three Blue States and Two Red States to Watch
January 25, 2024 | Ryan Maness
Tax policy is often at the forefront of state legislative debates, and this has been especially the case recently. In the past five years, states have grappled with tax policy decisions that made national headlines: Wayfair with its resultant nexus and marketplace collection laws; conformity (or not) to the Tax Cuts and Jobs Act; responses to the COVID-19 pandemic, including revenue concerns, filing delays, and emergency rules for remote workers; and, most recently, unprecedented budget surpluses due to outperforming tax systems and massive direct and indirect federal aid to states.
This early in 2022, it’s challenging to predict which states may be the most active in the tax policy space and which trends will dominate the conversation, but taking into account comments from legislators, on the ground information, and early legislative filings, the MultiState tax team has compiled a list of the top states and trends to monitor in the state tax policy world.
A proposed new Constitutional amendment has grabbed the attention of the tax community. The amendment would levy a 2.3% gross receipts tax on gross incomes over $2 million of qualified businesses, a new payroll tax on employers with 50 or more employees and employees making more than $49,900 per year, and a new surcharge on the individual income tax, with rates ranging up to 2.5 percent. The $163 billion in estimated new revenue would be used to establish a single payer healthcare system. At this point, this proposal seems unlikely to make the ballot and ultimately garner enough voter approval to pass, but it does signal that progressives are serious about single payer healthcare and increasing tax revenue to fund new social programs.
Kentucky legislators discuss tax reform regularly, and this year portends to be no different. A new report from the Tax Foundation has injected new energy into the tax reform debate in the Bluegrass State. The Tax Foundation report makes recommendations to reduce the corporate income tax, eliminate the Limited Liability Entity Tax, evaluate tax incentives, and more. The report does recommend “modernizing” the sales tax by taxing services to replace lost revenue. One concern is that the state may consider legislation which violates a fundamental principle underpinning the Tax Foundation’s report, which is that consumption (sales) taxes should not be imposed on business inputs. The most obvious example is professional services, which are predominantly purchased by businesses; taxing them would cause a host of problems. However, there are many unknown factors at play: would Democratic Governor Andy Beshear sign a Republican tax plan? (Republicans do have a supermajority.) Will the legislature have time to tackle this issue? On top of elections and surpluses – two issues not unique to the state – Kentucky also experienced a series of catastrophic tornadoes, and legislators will devote a significant amount of time addressing tornado recovery.
Property tax reform has been a perennial issue in Nebraska, but last March “Blueprint Nebraska”—a coalition of business and legislative leaders—released a report on ways that the state could modernize its tax code. Specifically, the report called for simplifying the income tax, reducing burdens of the property tax, and expanding the sales tax base. Media reports at the time quoted Sen. Linehan, chair of the Revenue Committee, saying that 2022 would likely be the year of action considering that the governor and 12 veteran lawmakers would be leaving their posts due to term limits.
With projected budget surpluses for the next few fiscal years and revenues coming in stronger than expected, most speculation is there will not be major tax increases or decreases. Progressive groups are looking to support a number of priorities including universal child care, consumer privacy, public housing, and meeting the state’s goal to reduce greenhouse gas emissions. It is possible that tax proposals could become part of these efforts. For example, prior legislation looking at repealing any tax incentives that support efforts that use fossil fuels could be part of a package that supports reducing greenhouse gas emissions. Proposals to offset looming unemployment tax increases are also expected. Finally, the “data tax” proposed in 2021 is likely to gather more attention this year.
Nearly every state has taken in record revenue and this makes budgeting trickier than one might imagine. No state is projecting a budget shortfall for FY 2023, which is the budget legislatures will be writing over the next few months. When revenues are tight, interest groups understand budget increases are unlikely. But with states awash in cash, many will expect significant increases for their favorite programs. The only saving grace for state legislative leaders is that 2022 legislative sessions are relatively short in most cases; with a big election coming, legislators in both parties will want to wrap up business as quickly and cleanly as possible.
With record revenues and an election on the horizon, we have already seen significant action in states where both the legislature and the governorship are under Republican control (a “trifecta”). Arkansas just recently again reduced its personal and corporate income tax rates. Although not a trifecta - North Carolina also again reduced income tax rates. Income tax rate reductions or eliminations have already been proposed in Indiana, Iowa, Kansas, Mississippi, and West Virginia (and we expect further introductions in the coming weeks), and, in Florida, the extension of the current lower corporate income tax rate is being considered. The politically and economically dubious “tax swap” - proposals to reduce income taxation by expanding sales taxation - seem to have appropriately fallen out of favor, but we will undoubtedly see those proposals in 2022 as well. See, for example, a pair of recently introduced Indiana bills: SB 372 and HB 1083, as well as our discussion of Kentucky herein. The long term question with all of these proposals is whether rate reductions will be sustainable when the economy and tax revenues inevitably turn down. North Carolina has provided a model for those looking to reduce rates, which is fairly straightforward: don’t budget to spend more than your slimmed down tax code can generate.
Despite record revenues, some progressive legislators will continue to advocate for tax increases to fund new programs. Their tax proposals generally target the “wealthy”—high income or net worth individuals and large corporations. For example, despite a rosy revenue outlook, legislators in Connecticut last year were disappointed that Governor Lamont proposed and signed a relatively modest budget that didn’t include major revenue increases or appropriations for progressive causes, and signaled that they will try again this year to push progressive priorities. Similarly, in both Colorado and New York tax increases were imposed on high income individuals and businesses even after it was clear new revenue wasn’t needed to balance the budget (in Colorado, the increases were adopted after the budget was enacted). While many legislators will shy away from major tax changes in an election year (more on that below!), some progressives will attempt to pass tax hikes on the business community and/or high-income taxpayers (e.g., the California single payer proposal), and actually campaign on the tax hikes as fulfilled promises.
A minority of legislators on both sides of the aisle have contemplated ways to levy punitive taxes on “Big Tech” in recent years, each party for its own reasons. “Tech taxes” refer generally to novel proposals to impose taxes on large companies seen as existing primarily in the digital or information technology space, including taxes on data and digital advertising. The scope of these policies, however, regularly extend far beyond the alleged targets and often would result in levies on a wide array of industries, both large and small. Maryland was the first state to take major, specific action on this issue by enacting a tax on digital advertising in 2021. Many believe the tax violates both federal law (PITFA) and multiple provisions in the Constitution, and there are two lawsuits pending regarding the tax. Seven states proposed similar taxes on digital advertising, and Connecticut and Massachusetts seriously considered the tax but ultimately did not enact it. Other states, such as New York, introduced taxes on data collection — a broad tax that would impact many types of businesses. No state enacted a tax on data collection, but committed legislators have made it clear that they will continue to consider these types of taxes.
Federal tax changes will continue to impact many state tax codes, either from scheduled changes from the Tax Cut and Jobs Act of 2017 (TCJA) or potential changes in the Build Back Better Act (BBBA).
Taxation of Foreign Source Income
TCJA: Pursuant to the TCJA, the federal section 250 deduction will decrease in 2026 from 50% to 37.5% for Global Intangible Low Taxed Income (GILTI) and from 37.5% to 21.875% for Foreign Derived Intangible Income (FDII).
BBBA (potential changes): The BBBA that passed the House would accelerate the reduction in the 250 deduction to 2023 and would lower the deduction to 28.5% for GILTI and to 24.8%.
Research and Experimentation Expenses
TCJA: Corporations can currently deduct 100% of their R&E expenses in the year incurred. However, beginning in 2022, the TCJA requires these expenses to be amortized over 5 years (15 years for foreign research). This will automatically increase the tax base in states with rolling conformity.
BBBA (potential changes): The BBBA would delay the impact of this change and not start the amortization until 2026.
TCJA: The TCJA limitation on interest expense (IRC sec. 163(j)) calculation changes from 30% of EBITDA to 30% of EBIT for calendar years beginning in 2022. This will increase the tax base in states with rolling conformity to the federal base that have not already decoupled from the federal limitation.
BBBA (potential changes): The BBBA would add an additional interest limitation for domestic corporations that are members of an international financial reporting group.
There are always challenges to enacting new tax packages, but this year in particular brings several mitigating factors. It’s an election year, which means many policymakers will want to avoid changes to the tax code because “tax reform” (as opposed to tax cuts…or increases in some states) in general can be unpopular with voters. Additionally, the pressure of reelection incentivizes legislators to adjourn session quickly so they can hit the campaign trail. Lastly, it may be counterintuitive, but as noted previously revenue surpluses can actually make it more difficult to budget because legislators are met with more demands for funding than they could possibly grant. In those cases, it can be tempting for legislators to wrap up the budget as quickly as possible to curtail the seemingly endless funding requests.
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. Click here to get in touch.
January 25, 2024 | Ryan Maness
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