U.S. state tax cuts for fiscal 2022 could complicate longer-term budgets


Thursday, Oct 7, 2021 / 6:08 AM / by Fitch Ratings / Header image credit: Arizona Mirror

U.S. states have cut taxes more than expected over the past fiscal season, with some of the most significant changes likely requiring tough budget choices going forward, according to Fitch Ratings. Fitch considers a state’s ability to maintain fiscal balance when assessing the credit implications of tax changes.

Permanent tax changes can pose fiscal challenges if they are primarily driven by one-time revenue surpluses, and states with lower levels of financial resilience due to low reserves or funds for rainy days are more likely to risk. More than a third of state governments have incorporated some form of tax relief into final FY2022 budgets, as exceptional revenue performance in FY2021 dramatically increased cash and reserve levels statutory.

Eighteen states have enacted tax cuts of some sort this year, 12 of which have cut income taxes, while six have enacted a mix of tax exemptions for federal stimulus and unemployment payments or have reduced property and / or utility taxes statewide. Minnesota and Wisconsin proposed tax increases in their executive budgets for fiscal year 2022, but ultimately reduced taxes in their final adopted budgets. Only five states have increased or enacted new income or sales taxes for fiscal 2022: Florida, New York, New Jersey, Washington, and Missouri, which have also implemented new tax cuts. .

Many of the tax cuts adopted were larger than those initially proposed at the start of this year’s budget season. Iowa and Missouri also accelerated the phased introduction of pre-existing income tax cuts by removing or modifying income triggers included in previous legislation. Iowa, Montana, Nebraska, New Hampshire, and Oklahoma cut multiple taxes at once, and Arizona, Iowa, Idaho, Montana, and Ohio cut tax rates. taxation while eliminating or consolidating entire tax brackets.

States cut taxes amid robust income growth in fiscal 2021 that exceeded their initially low forecasts made at the start of the pandemic. Multiple rounds of federal stimulus and the lifting of public health restrictions have resulted in multibillion-dollar operating surpluses for many states, increasing available cash and allowing for substantial deposits of funds on rainy days. Between January and June, most states revised their revenue guidance upward for fiscal 2021, with some increasing double-digit percentage point margins.

However, some states are now in a more vulnerable position if income growth slows down and returns to pre-pandemic patterns. Fiscal challenges, such as withdrawing federal aid and shifting consumer spending from goods to services, many of which are untaxed, are likely to dampen state revenue growth over the medium term.

Arizona, Nebraska and Iowa have adopted deep cuts in several tax categories. All three states had healthy reserves in fiscal 2020, which will be used to cushion short-term impacts, but the risk will increase in 2024 or 2025 if revenue growth stagnates while the latest scheduled reductions are fully implemented.

Smaller tax cuts may also prove impractical for some states such as Kansas and Oklahoma, where fiscal 2021 revenues have not significantly outperformed and / or where reserves are low for fiscal year 2021. rating category. Kansas’ fiscal 2022 tax cuts were modest, but the state’s zero rainy day fund balance remains a source of credit weakness. Even a modest tax cut could complicate Kansas’ ongoing tax consolidation if revenue growth returns to pre-pandemic levels. Oklahoma’s tax cuts, while moderate in their estimated short-term income impact, were larger than expected and could slow the state’s progress in rebuilding its depleted reserve cushion. pandemic given the moderate rebound in fiscal 2021 state revenues.

Tax changes proposed or adopted by states

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