It should come as no surprise most Americans saw a lower federal tax burden following the Tax Cuts and Jobs Act (TCJA). Tax Foundation data reveals 80 percent of filers saw a substantially lower federal tax liability following federal tax reform – and only 5 percent of filers saw a significantly higher tax liability. The TCJA tax relief benefited the vast majority of filers by doubling the standard deduction, doubling the child tax credit, and decreasing personal income tax rates for nearly every tax bracket.
Unfortunately, as the New York Times indicated, there was a concerted effort by the media and progressive pundits to portray the TCJA as a targeted tax break for the rich while middle and lower income families would see nothing. In reality, the effects of federal tax reform on individual tax burdens ran completely opposite to narratives peddled by biased media sources. Nearly 70 percent of filers with incomes between $30,000 and $50,000 saw a tax cut, while over 80 percent of filers with incomes between $50,000 and $100,000 owed less tax than previous years. These income ranges encompass a broad definition of “middle-class,’ meaning federal tax reform was actually a massive middle-class tax cut.
While over 100 million filers saw a tax cut following federal tax reform, it is true that some filers actually saw an increase in tax burden despite rate reductions. Part of the reason why some filers, particularly higher income earners in high-tax states, saw increased tax burdens was the $10,000 cap on state and local tax (SALT) deductions. Prior to the TCJA, filers in high-tax states were able to deduct a large percentage of their state and local tax liability from their federal tax burden. Now that SALT deductions are capped at $10,000, filers in high-tax states are starting to feel the pinch of bad state and local fiscal policies.
Since capped SALT deductions are a principal perpetrator behind increased tax burdens, tax policy discussions should refocus on the states following federal tax reform. Federal filers who saw tax burdens increase should consider the tax rates of the states and localities in which they live. Filers in California, New York and New Jersey were responsible for about 40 percent of all SALT deductions in 2016. According to the ALEC-Laffer Rich States, Poor States 2019 Economic Competitiveness Index, California, New York and New Jersey have top combined state and local marginal personal income tax rates of 13.30 percent, 12.70 percent and 11.75 percent, respectively, and have some of the highest total tax burdens in the country. States that see taxpayers as wallets to raid, like the three above, can no longer rely on the unlimited federal SALT deduction to protect them from the political and economic consequences of spendthrift fiscal policies. Taxpayers looking for relief from high tax rates should look to their state governments for the next wave of tax reform.
Some states have leaped at the opportunity to cut taxes following federal tax reform. Every state with an income tax matches their state definition of taxable income to the federal definition in a process called “federal tax conformity.” Since the federal definition of taxable income expanded, states conforming to a more expansive federal tax code would see effective tax increases often exceeding $100 million annually.
To avoid the disastrous economic effects from large effective tax increases at the state level, many states cut taxes through the process of federal tax conformity. Iowa cut every personal and corporate income tax bracket saving taxpayers over $100 million in fiscal year (FY) 2019. Nebraska expanded the state personal exemption, increased the state standard deduction, and coupled income tax brackets to inflation saving taxpayers $326 million in FY 2019 alone. Even Vermont, a state not known for fiscal conservatism, created a new standard deduction, personal exemption, and lowered the top three personal income tax brackets, saving taxpayers more than $29 million in FY 2019.
Many states, including California, New York and New Jersey, chose to pocket the conformity tax increase and increased spending rather than cut taxes. As residents become more sensitive to high tax burdens following the SALT deduction cap, ignoring the opportunity to cut taxes through federal tax conformity may have grave consequences for many states.
Despite a concerted effort to mislead by biased media outlets and pundits, official tax data demonstrates the Tax Cuts and Jobs Act resulted in tax relief for most hardworking American taxpayers.
While much of the national conversation on tax reform has focused on federal policy so far, state tax policy deserves renewed attention as SALT deductions are capped and states grapple with federal tax conformity. High-tax states will be confronted with the true political and economic costs of reckless tax and fiscal policy as residents can no longer deduct a large portion of their state taxes from their federal tax burden.
How states approach federal tax conformity may result in hundreds of millions in tax cuts, or hundreds of millions in effective tax increases and bigger government. The federal tax reform landscape may be settled for the time being, but the 50 states are the stage for the next dynamic act in tax reform.
Skip Estes is the legislative analyst with the Center for State Fiscal Reform at the American Legislative Exchange Council. Follow him on twitter @Skip_Estes.
Jonathan Williams is the chief economist at the American Legislative Exchange Council and vice president of the Center for State Fiscal Reform. Follow him on twitter @TaxEconomist.