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Tax reform's second windfall is occurring at the state level

Tax reform's second windfall is occurring at the state level
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Americans are beginning to enjoy the benefits from the first federal tax reform since Ronald Reagan, more than 31 long years ago. The American economy is responding in an overwhelmingly positive way.

According to a recent survey from Americans for Tax Reform, more than 500 businesses have publicly announced bonuses, wage increases, 401(k) match increases, expansions, charitable contributions and utility-rate reductions as the result of the federal Tax Cuts and Jobs Act (TCJA) signed into law by President Donald TrumpDonald John TrumpFive takeaways from Cruz, O'Rourke's debate showdown Arpaio files libel suit against New York Times IMF's Christine Lagarde delays trip to Middle East MORE in December.

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In addition, the recent national jobs numbers show unemployment has fallen to 3.9 percent — the lowest level since 2000 — and the National Federation of Independent Business (NFIB) reports record small business optimism. These are just a few of the early dividends of tax reform that will benefit hardworking American taxpayers.

 

However, the untold story of federal tax reform’s success is the opportunity the new law has provided policymakers across America’s 50 “laboratories of democracy,” where unexpected tax receipts that are directly linked to changes in the federal tax code have been a game changer in many state capitols this year.

This new state-level revenue has empowered state lawmakers to reduce tax rates on their own hardworking taxpayers, providing a double benefit from the federal tax cuts.

More than half of the states have released official reports on the budgetary impact of federal tax reform, and they overwhelmingly predict enhanced state revenue — even in states like New York, where Governor Andrew Cuomo, a Democrat, vigorously opposed the federal reform.

Gov. Cuomo opposed the federal legislation since it capped the deduction for state and local taxes (SALT) at $10,000 annually and could leave some high-income earners in extremely high-tax locations with larger tax bills.

However, with the extra revenue in Albany, Cuomo now has the opportunity to cut state-level tax rates and insulate taxpayers from any unintended effects of the federal change.

Federal tax reform benefits state budgets because a clear majority of states base their state income taxes on federal definitions of taxable income or adjusted gross income (AGI).

When federal changes “broaden the tax base” through policy changes such as eliminating the personal exemption, it also expands the income that is taxable at the state level.

Of course, Congress lowered the tax rates across the board and roughly doubled the standard deduction, so the vast majority of taxpayers will enjoy a large net tax cut at the federal level. However, in 2018, the tax reform action has now shifted to the state level.

After President Ronald Reagan signed the 1986 tax reform package into law, many states took advantage of the windfall and used it to reform their state tax systems and reduce tax rates. As the late Yogi Berra would say, it’s now “déjà vu all over again.”

Already in 2018, lawmakers in Georgia, Iowa and Idaho have used the federal tax reform to their advantage and enacted tax reforms this session to lower tax rates and broadly enhance their economic competitiveness.

Some of the changes have already been recognized in the "Rich States, Poor States: ALEC-Laffer State Economic Competitiveness Index," which I co-author annually with economists Arthur Laffer and Stephen Moore.

For instance, as lawmakers in Georgia and Idaho used the federal tax changes to implement significant rate reductions this year, Idaho’s ranking skyrocketed from 10th to second-best, and Georgia’s jumped from 17th to 11th.

Iowa’s recent tax reform package that will deliver more than $2 billion in tax relief over six years was not enacted in time to be included in the 2018 edition of the index.

These 2018 state tax reforms continue to build on a trend, as states continue to look for ways to become more competitive. All told, in the past five years, more than 30 states have significantly reduced their tax burdens.

The case studies from these states exemplify how states can indeed be the “laboratories of democracy” as described by U.S. Supreme Court Justice Louis Brandeis. No state has ever taxed, borrowed or spent its way to prosperity.

States that allow the government to heavily interfere with economic transactions through increased tax rates, burdensome regulations and bloated spending have lost economic vitality and have seen residents migrate to states with lower taxes and more competitive business climates.

The federal Tax Cuts and Jobs Act give states an unexpected chance to improve their competitiveness — that is the untold story of federal tax reform.

Some will choose to pocket the extra revenue and hope taxpayers don’t pay attention, but many states will use this opportunity provided by federal tax reform to grow their economies and become more competitive. The beauty of the American experiment is that it allows states to choose which path they will follow.

Jonathan Williams is chief economist at the American Legislative Exchange Council (ALEC) and vice president of its Center for State Fiscal Reform. ALEC is an organization of state legislators and private-sector representatives dedicated to the advancement of free-market and limited-government principles. Follow him on Twitter @taxeconomist.