May 2, 2001 11:36 AM | Permalink |
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President Bush’s proposed reductions in federal taxes are now under consideration in Congress. They include sharp cuts in personal income tax rates, new income tax breaks, and complete repeal of the federal estate tax. Although the tax cuts have been slightly scaled back in size by the congressional budget resolution, they still are expected to cost the federal government some $1.7 trillion over the next decade (including higher interest payments).
State and local governments, which rely on federal payments and programs for significant shares of their revenues, could find those funds endangered should the Bush tax cuts be enacted. The President’s budget outline, for example, projects that to pay for the cost of the tax cuts, federal appropriations will fall by a sixth as a share of the gross domestic product over the next decade. Domestic appropriations could be cut even more given the President’s apparent desire to increase defense outlays.
Lost federal funding may be the largest problem facing the states under the Bush tax program. But there is another, very important issue: the effects of the Bush tax cuts on state tax collections.
States stand to lose upwards of $35 billion dollars a year in revenues by 2012 if the Bush tax plan is adopted. The Bush program threatens to undermine funding for important public services and/or shift the burden of state taxation even further onto middle- and lower-income families–because virtually all of the endangered state revenues involve estate taxes and income taxes currently paid by the states’ wealthiest taxpayers.
1. Estate Tax Repeal & the States–Up to $18.5 Billion a Year in Direct Costs
Every state shares in a portion of the federal estate tax, through a mechanism commonly called the “pickup tax.” This is essentially a revenue-sharing tool by which the federal government gives each state about 26 cents for each dollar in net federal estate tax paid by a state’s
|States Potentially Losing the Largest Dollar Amounts from Repeal of the Federal Estate Tax
State-by-State Estimates for the year 2012, $-millions
|State “Pickup” Tax Lost||Endangered Other Inheritance Tax||Total Lost or Endangered||% of Natl Loss|
|California||$ 2,661||$ —||$ 2,661||14.4%|
|Totals, 10 states:||$ 9,724||$ 2,808||$ 12,533||67.7%|
In addition, 12 states impose supplemental estate or inheritance taxes.
Under the Bush tax plan, the revenue-sharing accomplished through “pickup taxes” would be repealed. In addition, states that impose supplemental estate or inheritance taxes would probably face heavy pressure to repeal them.
When the Bush estate tax repeal is fully in place in 2012 (as the House proposes), the loss of the pickup tax alone would cost state governments a total of $15.2 billion. If state supplemental estate and inheritance taxes are lost as well, the annual direct revenue loss to the states would grow to $18.5 billion.
In terms of dollars, the largest revenue losses would (or could) be experienced by:
- California: $2.7 billion in 2010 (pickup tax only).
- Florida: $1.9 billion (pickup only).
- Pennsylvania: $1.8 billion, including $521 million from the lost pickup tax and potentially $1,260 million in endangered supplemental inheritance tax.
- New York: $1.5 billion (pickup only)
- New Jersey: $1.2 billion, including $495 million from the lost pickup tax and potentially $655 million in endangered supplemental inheritance tax.
- Texas: $832 million (pickup only)
- Ohio: $733 million, including $522 million from the lost pickup tax and potentially $211 million in endangered supplemental inheritance tax.
- Illinois: $714 million (pickup only)
|States Potentially Losing the Largest Shares of Total Tax Revenues from Repeal of the Federal Estate Tax
State-by-State Estimates for the year 2012, $-millions
|Shares of total state tax revenues in danger||“Pickup” Tax||Endangered Other Inheritance Tax||Total Lost or Endangered||$-mill.|
|New Hampshire||1.9%||2.6%||4.5%||$ 146|
|District of Columbia||1.1%||—||1.1%||90|
- Connecticut: $680 million, including $306 million from the lost pickup tax and potentially $374 million in endangered supplemental inheritance tax.
- North Carolina: $590 million, including $283 million from the lost pickup tax and potentially $307 million in endangered supplemental inheritance tax.
Just the five biggest potential losers, California, Florida, Pennsylvania, New York and New Jersey, represent almost half of the total potential revenue loss nationwide.
As shares of total state tax revenues, the biggest direct losses from estate tax repeal would (or could) be experienced by:
- New Hampshire: 4.5 percent of total state tax revenue, including 1.9 percent from the lost pickup tax and 2.6 percent in endangered supplemental inheritance tax. (New Hampshire Governor Jeanne Shaheen has recently proposed to repeal the state’s supplemental inheritance tax.)
- Pennsylvania: 2.9 percent of total state tax revenue, including 0.8 percent from the lost pickup tax and 2.0 percent in endangered supplemental inheritance tax.
- Connecticut: 2.7 percent of total state tax revenue, including 1.2 percent from the lost pickup tax and 1.5 percent in endangered supplemental inheritance tax.
- New York: 2.7 percent of total state tax revenue (pickup only).
- Florida: 2.6 percent of total state tax revenue (pickup only).
- New Jersey: 2.2 percent of total state tax revenue, including 0.9 percent from the lost pickup tax and 1.2 percent in endangered supplemental inheritance tax.
- Vermont: 2.0 percent of total state tax revenue (pickup only).
- Delaware: 1.6 percent of total state tax revenue (pickup only).
- Oklahoma: 1.4 percent of total state tax revenue, including 0.8 percent from the lost pickup tax and 0.7 percent in endangered supplemental inheritance tax.
- Massachusetts: 1.4 percent of total state tax revenue (pickup only).
- Ohio: 1.4 percent of total state tax revenue, including 1.0 percent from the lost pickup tax and 0.4 percent in endangered supplemental inheritance tax.
A table showing the direct effects on all of the states of estate tax repeal is at the end of this paper as an appendix. As the next section of this paper details, however, these direct effects far understate the total impact of estate tax elimination on the states.
2. State Income Tax Losses from Estate Tax Repeal–Another $16.5 Billion a Year
A second effect of Bush’s proposed repeal of the federal estate and gift tax is the major negative impact it would have on income tax revenues, both federal and state. When the gift tax was first attached to the estate tax back in 1932, its purpose was not only to curb estate tax avoidance, but also to protect the integrity of the income tax. Without the gift tax, many wealthy people could find ways to make temporary, untaxed transfers of their assets to low- or no-tax entities, and then, after interest, dividends, capital gains and so forth have been realized, recover the proceeds.(1)
Recently, the congressional Joint Committee on Taxation took note of this huge problem and sharply revised its previous estimates of the cost of estate tax elimination. Repeal of the estate and gift tax is now expected to cost the federal government 82 percent more than the tax currently raises! By fiscal 2011, for example, repeal would cost $96.9 billion a year, compared to anticipated federal estate and gift tax revenues without repeal of $53.4 billion that year. The $43.5 billion added annual cost would stem from widespread income tax avoidance.(2)
The Joint Tax figures imply that the best-off one percent of taxpayers would take advantage of estate and gift tax repeal to avoid about a fifth of the federal income taxes they now pay on their capital gains, interest and dividends–an estimate that may well be conservative once creative lawyers and accountants get to work. State income taxes would be endangered by estate tax repeal, too, perhaps to an even greater degree than federal taxes, because of the ease of moving investment assets from state to state.
As a result, the cost to the states from elimination of the estate tax could easily reach $35 billion a year in combined estate tax and income tax losses once repeal is fully effective.
|Federal & State Revenue Losses from Repeal of the Federal Estate & Gift Tax
(Based on House-passed plan, not fully effective until fiscal 2012)
|fiscal yrs, $-billions||2003||2004||2005||2006||2007||2008||2009||2010||2011||2012||Source|
|FEDERAL:||JCT except 2012|
|Current federal estate & gift taxes||$ 34.9||$ 36.0||$ 36.4||$ 37.3||$ 39.8||$ 43.7||$ 46.4||$ 49.3||$ 53.4||$ 57.8|
|House phased-in estate tax repeal||–7.0||–9.1||–11.3||–13.1||–14.9||–19.8||–27.4||–33.7||–49.2||–104.7||JCT 03-11|
|Loss of estate tax||–5.7||–7.2||–8.5||–9.7||–10.9||–13.3||–17.4||–20.9||–28.2||–57.8||CTJ, based on JCT|
|Income tax losses||–1.3||–1.9||–2.8||–3.4||–4.0||–6.5||–10.0||–12.8||–21.0||–46.9|
|% of cost|
|Estate & gift taxes||81%||79%||75%||74%||73%||67%||63%||62%||57%||55%|
|Income tax losses add to direct loss||+23%||+26%||+33%||+35%||+37%||+49%||+58%||+61%||+74%||+81%|
|State estate taxes now||$ 11.2||$ 11.5||$ 11.7||$ 12.0||$ 12.8||$ 14.0||$ 14.9||$ 15.8||$ 17.1||$ 18.5||IRS/CTJ|
|Lost estate taxes||–1.8||–2.3||–2.7||–3.1||–3.5||–4.3||–5.6||–6.7||–9.0||–18.5||CTJ|
|Lost income taxes||–0.5||–0.7||–1.0||–1.2||–1.4||–2.3||–3.5||–4.5||–7.4||–16.5||CTJ|
|Total state losses||$ –2.3||$ –3.0||$ –3.7||$ –4.3||$ –4.9||$ –6.6||$ –9.1||$ –11.2||$ –16.5||$ –35.1||CTJ|
|Sources: Joint Committee on Taxation (JCT); Internal Revenue Service (IRS); Citizens for Tax Justice (CTJ) for 2012 and as noted.|
3. Loss of Federal Tax Deductions for State and Local Taxes
In a third strike against state revenues, the Bush tax plan would indirectly make sharp reductions in federal itemized deductions for state and local taxes. Obviously, the lower marginal income tax rates proposed by President Bush would reduce the value of all federal income tax deductions somewhat. But the effects of the Bush plan on itemized deductions for state and local taxes are especially significant, potentially reducing the value of these deductions by more than 50 percent nationwide, and by even larger amounts in higher-income states.
Under the Bush tax plan, taxpayers in the top fifth of the income scale, except the top one percent, would see their apparent tax cuts sharply reduced because the President’s tax cut plan would push millions of these taxpayers into the Alternative Minimum Tax. The “AMT,” as the name implies, is an alternative income tax that taxpayers must pay if it exceeds their regular income tax. The AMT was originally intended to curb upper-income tax sheltering, but because its brackets have not been adjusted for inflation, it threatens to affect many taxpayers without shelters over the upcoming decade.(3)
According to the Joint Committee on Taxation, by 2006, Bush’s tax cuts would double the number of taxpayers affected by the AMT, from fewer than 9 million to almost 19 million. That occurs because the Bush plan reduces the 28 percent and 31 percent regular income tax rates to 25 percent, but keeps the tax rates for the AMT at 26-28 percent.(4) (For the best-off one percent, the AMT effects are not very significant, because their top regular income tax rate will be 33 percent, down from 39.6 percent.)
Once in the AMT, taxpayers can no longer claim deductions for state and local taxes.
- Nationally, we calculate that for taxpayers in the top fifth of the income scale, excluding the best-off one percent, the Bush plan has the effect of denying them 78 percent of the state and local tax deductions they could otherwise take.
- Because most itemizers are in the top fifth of the population, the Bush plan’s AMT effect has the effect of cutting the total tax benefits from state and local tax deductions in half.
Such a large reduction in the federal tax benefits from state and local tax deductions could have a serious impact on the ability of states and localities to impose income and property taxes, since the effective burden of these taxes on the better-off would rise sharply under the Bush plan. The deductibility of state and local income and property taxes on federal itemizers’ tax returns means that for every dollar in income or property taxes paid to a state or local government, federal taxpayers who itemize get a federal tax reduction of as much as 39.6 cents (depending on what federal tax bracket they are in). The reduced federal income tax rates under the Bush plan, and the resulting AMT hike, would reduce the percentage of state income and property taxes that would be “exported” to the federal government in the form of reduced federal income taxes.
Reducing the ability of states to export their income and property tax burdens to the federal government in this way would make these taxes a less attractive option for state policy makers–and could encourage states to rely more on regressive sales and excise taxes (which are not deductible for federal itemizers) as a source of funding. That would not be good news for the majority of state taxpayers.
Beyond its major effects on the federal budget, the Bush tax program threatens to reduce state revenues by upwards of $35 billion a year once it is fully in place–and to make state tax systems even more regressive than they already are. These serious impacts on the states have not received the attention they deserve, but they should worry anyone who cares about the adequacy of state and local public services and the fairness of how they are funded.