States are flush with cash. Should they use it for tax cuts?

Many states have a surplus in their budgets from tax revenues and pandemic-related aid. Now lawmakers and governors are eyeing tax breaks to relieve consumers and taxpayers. But some raise concerns that tax cuts might jeopardize programs for low-income families. 

First Look

Soaring tax revenue and billions in pandemic aid from the federal government have left many states with an unusual problem – too much money.

The result is one of the most broad-based movements in recent memory toward giving consumers and taxpayers a break. In red states and blue, lawmakers and governors are proposing to cut taxes and fees, create tax credits, or delay tax and fee hikes that had been planned before the COVID-19 pandemic struck.

Even high-tax states controlled by Democrats, from California to New Jersey, are dangling the possibility. Among those are Washington state, where one Democratic senator has proposed cutting the state sales tax from 6.5% to 5.5%.

“We need to get money back in people’s pockets if we’re to make a full recovery from the high public health cost and economic cost of this pandemic,” said state Sen. Mona Das, the Democrat who proposed the measure. Legislative leaders in her party are cool to the idea of using temporary revenue to finance permanent cuts, but some have rallied behind a one-time sales tax holiday proposal.

States coffers are overflowing after nearly two years of Congress pumping out trillions to help the United States economy stay afloat through the pandemic, including sending billions to state governments. Most are enacting or considering tax cuts even while considering big boosts on public schools and infrastructure.

Income and sales taxes are on the chopping block as are vehicle license fees, gas taxes, and more.

In Maryland, Republican Gov. Larry Hogan has long pushed for a gradual elimination of income taxes for retirees, something he says will reduce the migration of people leaving the state to lower-tax places such as Florida when they’re finished working. He may finally have a window for striking a deal with the Democrat-controlled legislature.

The state’s projected surplus for the fiscal year that starts July 1 is $4.6 billion in a $58.2 billion budget. That is giving Governor Hogan leeway for a renewed effort to sell his plan. As part of the deal, he’s also calling for making permanent an enhanced income tax credit favored by Democrats for lower-income workers that was put into place last year as a temporary measure.

“We now can afford to do this,” Governor Hogan told reporters at the start of this year’s legislative session.

The idea is appealing to retirees such as Karen Morgan, a lawyer who worked for the state legislature and lives in a Maryland suburb outside Washington, D.C.

“It would be nice to not have to spend some of these limited resources on taxes, and that means that there is extra money to spend on health care,” said Ms. Morgan. “There’s extra money to spend on just managing my life. You know, it doesn’t get any easier the older you get.”

For Maryland and other state governments, the fiscal fallout from the pandemic has turned out to be the opposite of the calamity they were bracing for in the spring of 2020.

The federal government has allocated states and local governments about $500 billion in general relief, plus more for specific areas such as education. It has offered separate aid to businesses and committed to $1 trillion in infrastructure spending, with much of that money funneled through states.

And most high-earners avoided layoffs during the pandemic and investors have done well – keeping income tax receipts high. Consumers have used that money to buy a lot of goods: home-office furniture, patio heaters, vehicles. That’s sent sales tax revenue, a key source of government income in most states, soaring.

“States have more money than they can realistically and sustainably spend,” said Jared Walczak, vice president of state projects at the Tax Foundation, a Washington-based think tank that advocates for tax policies fostering growth.

Mr. Walczak counted 16 states with income tax cuts last year, including a move toward a flat tax in Arizona and a sweeping one in Arkansas that was passed alongside a tax credit for low-income earners. The Urban Institute tallied 29 states that cut taxes or expanded tax credits last year.

Mr. Walczak says more than a dozen states are seriously considering income tax reductions this year.

He said states need to consider tax cuts because the pandemic made it clear that many people can move to a more desirable place and keep working remotely. But some plans might go too far – and some tax cuts could end up disproportionately hurting those on lower incomes.

A proposal in Republican-dominated Mississippi to phase out the personal income tax could drag down revenue enough to force cuts in state government spending in future years. The plan already has passed in the House, but Senate Republicans are calling for shallower cuts.

In addition to the income tax proposal, the House bill would reduce the taxes people pay each year to renew license plates for their vehicles and cut the sales tax on groceries. But the sales tax on most other items would rise from 7% to 8.5%.

“The end result would be a tax code that rewards work and is fairer for everyone,” said Republican state Rep. Trey Lamar, chairman of the tax-writing House Ways and Means Committee.

But Deloris Suel isn’t convinced the broader sales tax boost – which is not included in the Senate GOP plan – would be fair. She operates a child care center in Jackson and said the changes would end up costing the low-income families her center serves. Ms. Suel said a higher sales tax would hit them hard and would not be balanced by eliminating the income tax because many of them make too little to be required to pay it now.

Ms. Suel said lawmakers should evaluate the impact of tax cuts before rushing to make a decision.

“Sometimes, Mississippi joins in for the sake of being part of something,” she said.

An analysis by One Voice, which advocates for vulnerable and marginalized people, found that the tax plans would save $30,000 a year for the highest-income people in the state but increase the overall tax burden slightly for those making under $19,000.

Seeking more widespread benefits, taxes on groceries, which are in place in about a dozen states, are being targeted.

That includes Illinois, where the governor has proposed a one-year suspension that would save consumers in the state a collective $360 million. Democratic Gov. J.B. Pritzker has pitched it as a way to combat inflation, along with relief at the gas pump and on property tax bills.

In Oklahoma, where the GOP-led legislature cut individual and corporate income tax rates last year amid higher-than-expected revenue, some Republicans are talking about even more tax cuts, including the sales tax on groceries.

Rep. Sean Roberts, a Republican who also is running for Congress, wants a public vote on whether to remove the grocery tax.

“We currently have a surplus in funds and revenues are up, so now is the time to bring this much-needed relief to Oklahoma families,” he said.

Tax and fee cuts are on the table in Colorado, New York, Rhode Island, and Utah. Even in tax-happy California, Democratic Gov. Gavin Newsom is proposing delaying the next step in a multi-year increase in the gas tax.

But some economists caution that states should be careful about making permanent tax cuts, noting the flush times won’t last forever.

“What goes up must come down,” said Michael D’Arcy, who follows public finance for Fitch Ratings.

This story was reported by The Associated Press. Geoff Mulvihill reported from Cherry Hill, New Jersey. Also contributing to this article were AP writers James Anderson in Denver; Andrew DeMillo in Little Rock, Arkansas; Rachel La Corte in Olympia, Washington; Jennifer McDermott in Providence, Rhode Island; Sean Murphy in Oklahoma City; John O’Connor in Springfield, Illinois; Emily Wagster Pettus in Jackson, Mississippi; and Lindsay Whitehurst in Salt Lake City.