Struggling states could lose as much as $5.3 billion in tax collections during the next few years in an unintended consequence of one of the lower-profile federal tax cuts that President Obama signed in December, according to a report released Tuesday.
The tax-cut package the president signed in December is best known for extending the Bush-era tax rates for two years and giving a one-year payroll tax cut to most Americans. But it included a business tax cut that could blow a hole in state budgets: a provision allowing businesses to deduct the full value of new equipment purchases from their taxes through 2011.
That cut, intended to spur the economy by encouraging businesses to spend more money on equipment, could end up costing 19 states as much as $5.3 billion in lost revenue over the next few years, according to the report, by the Center on Budget and Policy Priorities, a research organization based in Washington.
The 19 states stand to lose money because they link their state tax laws to federal tax law. So the newly allowed federal tax deductions that businesses in those states take will lower their taxable incomes, which would in turn have the effect of driving down state corporate and income tax collections.
The change could cost Illinois, North Carolina, Pennsylvania and other states hundreds of millions of dollars of lost revenue unless they decide to enact laws decoupling their state tax laws from the federal ones, the report said. When similar cuts have been passed before, it noted, many states have chosen to break with federal laws.
But some states do not intend to do so this time. In Pennsylvania, which the report estimated could lose $833 million in revenues over the next few years, the state’s Department of Revenue announced last month that it had settled on a “business-friendly” interpretation of the law that could benefit as many as 117,000 corporate taxpayers.
The department said the new policy would not affect Pennsylvania’s revenues in the long run because companies would simply be taking full deductions now, rather than spreading them out over several years. But this is a hard time for Pennsylvania to give large tax breaks up front: the state faces an estimated $4 billion deficit in the coming fiscal year.
The unexpected tax change is just one example of how difficult it can be for states to perform one of their most important tasks: guessing how much money they will collect in the coming year, so they will know how much will be available to spend.
Those educated guesses, known as revenue estimates, were the subject of another report released Tuesday by the Pew Center on the States and the Nelson A. Rockefeller Institute of Government. It found that errors in those revenue estimates have grown progressively worse during the last three fiscal crises, and that during the first year of the Great Recession states overestimated the amount of money they expected to collect by $49 billion, leading to difficult midyear budget cuts. Some states were off by more than 25 percent, it found.
During periods of economic growth, the report found, states tend to underestimate tax collections, resulting in surpluses at the end of the year. But states tend to underestimate the severity of economic downturns: then, they usually come up with overly optimistic estimates of how much they expect to collect. The report warned that “as forecasting revenue accurately becomes more difficult, states have a tougher time balancing their budgets to provide taxpayers the services they expect and ensuring the long-term fiscal health of the state.”