Tax Trends from the Recession

Still feeling the impact of the recession, states have struggled to balance their budgets and stay competitive. As a result in 2011 state tax collections grew by more than typical, second only to 2008.

Since 1997, state tax collections grew 4% on average. However, states’ spending projections have exceeded that rate, and as such they’ve taken to find the money elsewhere.

The Tax Foundation has listed the top 10 tax trends during the recession and the recovery.

10. Cigarette tax increases tapering off

When states need to raise revenue it’s not uncommon for them to raise taxes on specific, unpopular groups. As a result, states implement cigarette, liquor and soda taxes, among others. However, the trend of increasing taxes on cigarettes has tapered off. In general, these taxes are very unpopular, but there was a considerable amount of state-to-state smuggling.

9. State abuse of Medicaid matching funds

The open-ended nature of the Medicaid matching program can allow states to abuse it to bridge budget gaps. Through the Federal Medical Assistance Percentage formula, the federal government matches funds based on the state’s level of poverty and unemployment.

During the recession, states were “taxing health care providers, using the collected revenue to qualify for federal matching funds, and then using the federal dollars to compensate Medicaid providers,” according to the Tax Foundation. The result was a flurry of new state medical taxes.

8. Insufficient rainy day funds

Although the whole purpose of the “rainy day” fund is to be used during an economic downturn, the reserves were mostly inadequate for the 2008 recession. Only Alaska and Texas really have sizable fund amounts remaining.

According to the Tax Foundation, during good economic times states should save between 2.4% and 2.8% of each year’s revenues to have enough funds to offset revenue shortfalls during a downturn.

7. Collapsing unemployment insurance systems

With record high levels of unemployment, there was a lot of pressure on the federal-state unemployment insurance tax and benefit system over the last few years.

“Over the past three years, 34 states and the U.S. Virgin Islands exhausted their unemployment insurance trust funds and have borrowed from the federal government to pay unemployment benefits,” according to the Tax Foundation.

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6. Tax abolition

Some states are actually looking to abolish major taxes now. The last major tax that was abolished was Alaska’s income tax in 1980. But doing away with income or sales tax means spending cuts or higher taxes.

The states that are most looking to abolish major taxes are those in the middle of the country. Oklahoma, Kansas, Missouri, Ohio, Indiana, North Dakota and Pennsylvania are all currently looking at some major tax repeals.

“If all proposals come to pass, an income tax-free zone could stretch from Texas north through Oklahoma and Kansas and east to Missouri,” according to the Tax Foundation.

5. “Amazon” taxes

The online retail giant Amazon.com is the main target of this tax, which more and more states are looking at. The tax is a way to get around the fact that a state’s taxing power ends at its individual borders.

In 2008, it all began in New York, which passed a law that it can tax people or businesses not physically in the state if they enter into agreement with in-state resident involving commissions for referring potential customers and have gross receipts from sales by out-of-state companies from referrals within the state which total more than $10,000 in a 12-month period.

After New York, Rhode Island and North Carolina adopted similar laws. California and Hawaii passed laws that were then vetoed, while Illinois’ law was ruled unconstitutional. Colorado faced too much opposition but passed a law that essentially forces tax collection.

4. Sales tax increases

Arizona, California and Nevada all implemented temporary sales taxes and North Carolina increased its sales tax multiple times from 4.25% to 4.5% to 5.75% before finally dropping it to 4.75%. New Mexico’s increase of only 0.125% was the smallest.

States that implemented sales tax changes from 2007 to 2011 were: Arizona, California, Connecticut, Indiana, Iowa, Kansas, Maryland, Massachusetts, Minnesota, Nevada, New Mexico, North Carolina and Utah. The District of Columbia also instituted an increase.

3. Corporate tax reductions

America has the highest corporate income tax rate in the industrialized world right now. Plus, state corporate income taxes are levied in addition to a high federal tax.

Since 2008 states have been taking efforts to lower corporate tax bills so businesses don’t take non-corporate forms that pay under the individual tax code. In addition to reducing rates, most states are offering incentive packages to new or expanding businesses.

2. Income tax reform

Although tax systems should have broad bases and low rates, most state tax systems have high tax rates on a relatively narrow tax base. Utah and Rhode Island were some of the leading states to adopt reforms. Maine recently proposed a tax reform as have Kansas and South Carolina. Meanwhile, Georgia and Arizona’s proposals both fell.

1. Millionaires’ taxes

Going completely against what a tax system should be (see above), the millionaires’ tax enacts a high income tax on the small number of people with large incomes. And the tax typically hits income at a much lower level than a million.

“Notwithstanding their tax increases on high-income earners, New Jersey, Maryland, and California continue to experience serious budget shortfalls that are actually comparatively worse than those in other states,” according to the Tax Foundation.