Tax Reform In The States

Report Outline
Revenue Changes Make Waves in the States
Lost Sales Tax and Bond Write-Offs
Legislative Flurry: Aye and Nay

Revenue Changes Make Waves in the States

The massive tax reform measure Congress approved in September was touted by its proponents as being designed to make the tax code fairer, by easing the tax burden on middle-income families and shifting more taxes onto business concerns. But now that tax reform is on its way to becoming law, another battle over the fairness issue may be looming. While tax reform may translate into lower federal tax bills for most taxpayers, preliminary computations show that in many states it will mean higher combined state, local and federal income taxes.

Under the Tax Reform Act of 1986, state and local income taxes in jurisdictions where tax laws are coupled to the federal tax code, will rise automatically. This is because the new law's base-broadening provisions have done away with many tax shelters and rendered more income taxable, at the state and local levels as well as federally. In the federal tax code, on average, the higher taxable income is more than offset by lower individual tax rates, a major provision of tax reform. But most state and local income taxes where tax laws are coupled to the federal code will increase unless legislatures take action.

In coming months, the income tax issue is expected to spark heated debate at the state and local levels. Governments will be under pressure from taxpayers to return “windfall” state and local income tax revenues created by the new law. Some state officials have already pledged to do so. But governments in economically hard-pressed states faced with budget shortfalls may try to use the windfall revenues to erase budgetary red ink.