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The Economic Consequences of Raising Taxes

For states short of revenue to meet public needs, tax increases — particularly on higher-income households — can lessen reliance on spending cuts of a magnitude that would harm vulnerable residents and threaten economic performance. Like spending cuts, tax increases remove some demand from the economy by reducing the amount of money people have to spend. But as Nobel prize-winning MIT economist Joseph Stiglitz and Peter Orszag (then a Brookings Institution economist and now the director of the Office of Management and Budget) explained in a 2001 analysis, tax increases can be less detrimental to state economies than budget cuts because some of the additional tax payments will be made from savings rather than from money that would otherwise be spent. Since higher-income families tend to save more of their income than less-affluent families, tax increases on them are the least damaging approach. [9]

It is sometimes argued that raising taxes will slow the rate of states’ economic recovery. Available data do not appear to support this argument. Tax measures that states used to help balance budgets during the 2002-04 period appear to have had no adverse effect on states’ economies. When compared on major measures of economic progress, states that raised taxes performed at roughly the same level as states that did not. Table 1 compares the 29 states that raised taxes during the 2002-04 period with those that did not. It shows that during the subsequent period of economic recovery — from 2004 through 2007 — the states that raised taxes fared about as well as those that didn’t. In short, neither economic theory, nor recent history, support allowing a fear of weakened economic growth to affect the decision of whether or not to raise taxes.

Some states that have raised taxes during the current recession still face large projected shortfalls, in part because their tax increases were only temporary. For those states whose tax increases are to expire before the states fully recover, extending the temporary measures would provide much-needed revenue. Several other states are now facing increased budgetary pressures in part because they reduced taxes during the past two years. For states scheduled to carry out previously enacted tax reductions, such as New Mexico, postponing those reductions would likely be less detrimental to the state’s economy — and to vulnerable residents — than the deeper spending cuts that would occur if revenues were not retained.

Conclusion

Since the beginning of the most severe national recession since the Great Depression, states have experienced an unprecedented decline in revenues while having to address increased public needs stemming from rising unemployment. The budget gaps states have faced the past two years have been greater than the shortfalls reported during all four years of the prior recession.

To close the budget gaps created by this recession, at least 42 states cut spending the past two years; 33 raised revenues. For 20 of these states, the revenue increases were significant, equivalent to at least 1 percent of their total revenues. All types of taxes — personal income, sales, business, and excise taxes and a wide variety of fees — were increased.

Budget shortfalls are likely to continue at least over the next two years and could be as large as the gaps in the past two. Two-thirds of the states are facing midyear deficits for fiscal 2010 and 38 already have addressed or are facing budget gaps in 2011. As revenue forecasts continue to be bleak, additional shortfalls may develop.

The availability of federal recovery assistance over the past two years lessened the need for states to make cuts or raise taxes. However, as matters stand, federal aid is not likely to be available after December 2010, at least not in the manner provided under the American Recovery and Reinvestment Act. States will then have to address these large budget shortfalls with measures that include deeper spending cuts and more increases in taxes.

The tax actions that states have taken during the past two years may provide the basis for further measures. Tax increases adopted as temporary can be extended. Tax reductions already adopted can be postponed or rolled back. Expanding the sales tax to more services and to Internet sales would add to revenues not only during this period of recovery but also as states’ economies continue to grow.

This recession has had such a profound impact on state budgets that the solution cannot be just to make more spending cuts. The effects of doing so on people in need and on states’ economies would jeopardize recovery. Rather, a balanced approach that includes revenues is the prudent course for states to take.

APPENDIX 1: Details of Major Tax Increases Enacted in 2008 and 2009 for States that Increased Taxes, by Tax Type

Personal Income Taxes

• In 2009, California enacted a temporary 0.25 percentage point increase in each of the state’s income tax brackets, effective for tax years 2009 and 2010. A tax credit for dependents was also temporarily reduced. Income tax measures are expected to increase tax revenues by more than $5 billion in the coming fiscal year.
• Colorado ended taxpayers’ ability to deduct capital gains income derived from assets or businesses located within the state. This change will generate about $15.8 million per year in new income tax revenues.
• In 2009, Connecticut enacted permanent changes to its brackets and rates. A new top bracket starts at $500,000 for single filers, $800,000 for heads of households, and $1 million for married couples filing jointly. The tax rate on incomes above those thresholds increased to 6.5 percent from 5 percent and will take effect for tax year 2009. This change is estimated to raise $400 million.
• Delaware temporarily increased the top marginal tax rate by one percentage point to 6.95 percent on income over $60,000. This change will generate about $70 million in new revenues in 2010. Also, Delaware eliminated an exemption from taxes for lottery winnings.
• Hawaii adopted a measure temporarily creating three new state income tax brackets. Beginning in tax year 2009, for married couples the rates will be 9 percent on income between $300,000 and $350,000, 10 percent between $350,000 and $400,000, and 11 percent above $400,000. The previous top tax rate was 8.25 percent on all income over $96,000. These changes are expected to increase tax revenues by nearly $100 million during the fiscal 2009-2011 biennium and are set to expire after tax year 2015. The state raised the standard deduction and the personal exemption by 10 percent, which will lower tax bills for low- and moderate-income families. However, these increases will not apply until 2011.
• In Maryland, a new top rate of 6.25 percent took effect in 2008 on income greater than $1 million, regardless of filing status. The increase is scheduled to expire after three years. Maryland also added three new rates ranging from 5 to 5.5 percent, with no expiration date, on income from $150,000 to $1 million for single filers and $200,000 to $1 million for joint filers. This is estimated to raise $113 million.
• New Jersey increased income taxes on households with incomes above $400,000. For one year, the tax rate on joint filers with incomes between $400,000 and $500,000 will rise to 8 percent from 6.37; the rate on income between $500,000 and $1 million will increase to 10.25 percent from 8.97 percent; and a 10.75 percent rate will apply to income over $1 million. These changes will generate about $1 billion in fiscal 2010. Additionally, New Jersey will tax lottery winnings over $10,000 beginning in 2009. This action is estimated to increase revenues by $8 million.
• In 2009, New York enacted two new temporary income tax rates for the highest-income filers. For households with taxable income above $500,000, regardless of filing status, the tax rate rises to 8.97 percent from 6.85 percent; for those with taxable income below $500,000 but above $200,000 for single individuals, $250,000 for heads of households, and $300,000 for married couples filing joint returns, the rate increases to 7.85 percent from 6.85 percent. These rates are in effect for three years.
• In addition, New York placed limits on itemized state income tax deductions for taxpayers making over $1 million and reduced a state-funded credit on New York City’s personal income tax. The changes are projected to raise more than $4 billion a year.
• In 2009, North Carolina placed a temporary surcharge on upper-income taxpayers, effective for tax years 2009 and 2010. This surcharge is added to the filer’s tax liability. Married filers with income over $250,000 and single filers with income over $150,000 calculate their tax under previously existing law and then increase it by 3 percent. For married filers with income between $100,000 and $250,000, and single filers with income between $60,000 and $150,000, the surcharge is 2 percent. This is estimated to raise revenues by $177 million in 2009.
• Oregon enacted a measure adding two brackets at the top of the state’s income tax structure. Married couples will pay 10.8 percent on income between $250,000 and $500,000 and 11 percent on income over $500,000. These rates will be in effect through 2011. After 2011, the top rate will fall to 9.9 percent for joint filers with income over $250,000. These changes are projected to generate more than $230 million in each of the next two fiscal years. Oregon’s previous top rate was 9 percent on all income over $15,200. These measures were approved by the voters in January 2010.
• Rhode Island enacted legislation that will treat capital gains income as ordinary income for tax purposes regardless of how long an asset has been held. Previously, capital gains were given preferential treatment. It is expected to generate $23.6 million in the current year. At the same time, the state expanded personal income tax credits and continued to phase in an optional flat tax, which offset the revenue increase.
• Vermont enacted a budget that includes several major changes to the state’s income tax structure. Although all income tax rates were lowered, net revenue will increase. The package eliminated a 40 percent exemption on capital gains income, replacing it with a flat exemption of $2,500. This new exemption will rise to $5,000 beginning in tax year 2011. Lawmakers capped the amount of state and local income taxes that can be deducted from federal adjusted gross income at $5,000. On net, income tax provisions in Vermont will raise $9 million in new revenue in fiscal year 2010.
• Wisconsin enacted a new 7.75 percent income tax bracket on all income over $300,000 for married couples and $225,000 for individuals and heads of households. The exclusion for capital gains income was lowered to 30 percent from 60 percent. These changes will generate about $280 million in fiscal year 2010.

Sales Taxes

• California enacted a temporary 1 percentage point increase in the sales tax rate for two years. It is expected to generate about $4.5 billion in fiscal year 2010.
• The Colorado legislature temporarily extended the sales tax to the sale of tobacco products, which is estimated to raise $32 million in the coming fiscal year.
• In Delaware, the public utilities gross receipts tax was extended to include direct-to-home satellite services, for a revenue increase of almost $8 million.
• Illinois began taxing soda, energy drinks, certain candies, and personal hygiene products at 6.25 percent rather than the food tax rate of 1 percent. This is estimated to raise about $100 million.
• Indiana increased the sales tax rate to 7 percent from 6 percent for a revenue increase of almost $1 billion.
• Kentucky extended the state’s sales tax to include alcoholic beverages. The change will generate about $52 million each year.
• Maine expanded the sales tax to include amusement parks and sporting events and a range of maintenance and service transactions, including auto repair and dry cleaning. The meals and lodging tax was also increased to 8.5 percent from 7 percent. (The package also replaced the state’s graduated income tax structure with a flat 6.5 percent rate plus a 0.35 percentage point surcharge on income over $250,000.) In total, compared to current law, tax revenues were expected to be modestly higher in fiscal year 2010 as a result of these changes. The implementation of the reform package has been delayed, pending voter approval in June 2010.
• Massachusetts raised about $900 million in fiscal year 2010 by increasing the sales tax rate by 1.25 percentage points to 6.25 percent. The exemption on alcoholic beverages was eliminated, generating about $95 million in new revenues this year.
• In Nevada, the sales tax rate was temporarily increased to 6.85 percent from 6.5 percent. This change will raise revenues by $280 million over the next two years.
• New York raised sales tax revenues by about $73 million by taxing a broader range of companies previously selling tax-free over the Internet, and by an additional $23 million by taxing certain types of transportation services like limousine and car hires.
• North Carolina expanded the sales tax base to cover goods purchased over the Internet and temporarily increased the sales tax rate by 1 percent, for a net increase of almost $1.1 billion.
• Rhode Island enacted legislation requiring certain companies to collect sales taxes on goods purchased over the Internet, estimated to raise $3 million.
• Tennessee extended the sales tax to include software maintenance contracts and limited a sales tax exemption on computer software. These changes will generate about $10.5 million per year in new revenues.
• In 2008, the Utah legislature increased the sales tax rate to 4.7 percent from 4.65 percent.
• Vermont extended the sales tax to include liquor and digital downloads, for a revenue increase of around $3 million.
• Wisconsin entered the multi-state Streamlined Sales and Use Tax Agreement (SSUTA) — a compact that simplifies sales tax collections for participating businesses. The state also altered its method for taxing prewritten computer software and expanded the sales tax to include digital products, such as music and video downloads and subscriptions to online periodicals. Sales tax revenues will rise by over $30 million in fiscal year 2010 as a result of these actions.

Business Taxes

• California temporarily suspended the net operating loss deduction in 2008, a suspension which began phasing out in 2009; the state had a net increase of over $600 million over the two-year period. Starting in 2010, California will permit net operating losses to be applied to prior years, as is permitted under federal law. Also, the losses may be among the various subsidiary corporations within the unitary corporate group or family under the state’s combined reporting rules, thus resulting in a revenue loss in future years.
• Connecticut imposed a 10 percent surcharge for companies that make at least $100 million and pay at least $250 in taxes. This increase expires after three years. While Connecticut permits combined reporting on a voluntary basis, the state imposes a “preference tax” on companies that so elect. In 2009, Connecticut doubled the maximum preference tax. Along with other smaller changes, Connecticut will have a net increase of about $84 million in 2010.
• Delaware temporarily increased the maximum corporate franchise tax to $180,000 from $165,000, raised the gross receipts tax, and increased various smaller taxes and fees.
• Hawaii temporarily capped the use of various economic development credits for a $75 million revenue increase.
• Indiana capped the Media Production Expenditure Income Tax Credit for a revenue increase of nearly $10 million in fiscal year 2009.
• Maryland tightened the cap on corporate income tax credits for mined coal, which will increase business tax revenues by $5 million in fiscal 2010.
• Massachusetts instituted combined reporting in 2008, along with a phasing-in of corporate income tax rate reductions. These measures led to a net revenue increase of $390 million over the initial two years.
• Minnesota changed the rules surrounding foreign operating corporation, raising $76 million in 2008.
• Nevada temporarily altered its business payroll tax, generating $346 million in new revenue in the fiscal 2010-2011 biennium. For non-financial businesses, the tax rate on the first $250,000 in payroll is lowered to 0.5 percent from the flat rate of 0.63 percent. The tax rate on payroll over $250,000 rises to 1.17 percent.
• In New Hampshire, the interest and dividends tax was extended to include profits of limited liability companies and other types of entities. The state’s business profits tax filing threshold was changed; all businesses, regardless of their income level, are now required to file a return. These changes will increase business tax revenues by about $21 million each year.
• New York imposed a new payroll tax to support public transportation in the New York City metropolitan area, which is expected to generate $1.5 billion. In addition, the state reformed some tax credits and made a small expansion of firms covered by various business taxes. These changes are expected to generate an additional $400 million.
• North Carolina imposed a temporary surcharge on corporate taxpayers, but also expanded business tax credits, which offset the revenue increase.
• Oregon increased the corporate income tax rate for corporations with taxable income above $250,000 to 7.9 from 6.6 percent. This rate will be in effect for 2009 and 2010. It is then slated to fall by 1 percent for 2011 and 2012. After 2012, the higher rate will be applied only to taxable income over $10 million. The minimum corporate income tax was increased, depending on the amount of sales in Oregon. For a firm with more than $100 million in Oregon sales, the minimum tax is now $100,000; previously, the minimum tax was $10. These changes will increase business tax revenues by more than $200 million in the fiscal 2010-2011 biennium.
• In Rhode Island, the gross premiums tax on health insurance providers was extended to include previously excluded insurers and rates were increased in both years. The revenue increase is estimated to be $24.4 million annually.
• Tennessee increased franchise and excise tax revenues by eliminating an exemption on rental income earned by certain non-corporate businesses. This change increased revenues by more than $25 million per year.
• Wisconsin instituted “combined reporting,” which requires companies with subsidiaries to calculate their profits as one sum instead of allowing various entities to report separately. One result is that in-state and multi-state corporations will be taxed more equivalently. Under combined reporting, corporate income tax revenues will increase by over $90 million per year. The state also generated about $45 million per year in new tax revenues by adopting a “throwback rule,” which ensures that profits made in a state in which a corporation may be exempt from income tax are taxed instead by the corporation’s home state.

Motor Vehicle, Tobacco, and Alcohol Excise Taxes

• Arkansas raised the cigarette tax by 56 cents to $1.15 per pack. The tax on other tobacco products was increased to 68 percent of the wholesale price, from 32 percent. These changes are expected to generate over $70 million per year in new tax revenue.
• California made changes regarding the classification of malt beverages for a $38 million revenue increase.
• Connecticut added a dollar per pack to the cigarette tax, for an increase of nearly $100 million.
• Delaware increased the tax on cigarettes to $1.60 from $1.15 per pack. This is expected to generate $17.5 million.
• Florida enacted legislation adding a $1 surcharge to the tax on each pack of cigarettes. A surcharge equal to 60 percent of the wholesale price also was imposed on other tobacco products. These surcharges will increase tax revenues by $959 million in the coming fiscal year.
• Hawaii increased the cigarette tax by 2 cents per pack. The state also increased taxes on other tobacco products by various levels. Depending on the product, taxes on tobacco other than cigarettes will range up to 70 percent of wholesale price; the previous rate was 40 percent of the wholesale price. These changes will increase tax revenues by nearly $50 million in the upcoming fiscal 2010-2011 biennium.
• Idaho removed an exemption valued at 0.0401 cents per gallon on motor fuels blended with ethanol. This is estimated to raise $16 million in new revenues each year.
• Kentucky doubled its cigarette tax to 60 cents per pack from 30 cents, which will raise more than $106 million a year.
• Maine changed its method for calculating the tax on smokeless tobacco. Beginning in fiscal year 2010, taxes on smokeless tobacco will be based on weight, at a rate of $2.02 per ounce, for a revenue increase of about $2 million.
• Massachusetts added a dollar per pack to the cigarette tax for a revenue increase of $175 million.
• Minnesota instituted a two-step gas tax increase in 2008, for $157 million in increased revenue. Motor vehicle registration taxes were also raised for an additional $64 million.
• Mississippi increased the cigarette tax to 68 cents per pack from 18 cents, which is expected to raise more than $100 million in fiscal 2010.
• Montana eliminated its preferential tax treatment of ethanol, for an increase of $6 million.
• New Hampshire increased the cigarette tax to $1.78 from $1.33 per pack — a change that will increase revenues by $35.2 million in fiscal year 2010. In 2008, New Hampshire added 25 cents per pack to the cigarette tax for an additional $18 million.
• New Jersey increased the cigarette tax by 12.5 cents to $2.70 per pack and increased the tax on alcoholic beverages, excluding beer, by 25 percent. These changes will generate about $50 million in new tax revenues in fiscal year 2010.
• New York increased the cigarette tax in 2008 to $2.75 from $1.50, for a revenue increase of nearly $300 million. New York raised an additional $14 million in 2009 by increasing the state excise tax on beer and wine to 30 cents per gallon from 18.9 cents. The state also changed the method for taxing cigars to generate about $10 million in fiscal year 2010.
• North Carolina increased the excise tax on tobacco by 45 cents a pack and the excise taxes on beer, wine, and liquor by various rates, for a total increase of $94 million in 2011.
• Oregon added temporary surcharges of 50 cents on distilled liquor and 25 cents on miniature bottles through June 2011, increasing revenues by about $24 million for the biennium.
• Rhode Island increased its cigarette tax by $1 to $3.46 per pack. Rhode Island also added 2 cents to the gas tax for a $13 million increase.
• Vermont increased the cigarette tax by 25 cents, to $2.24 per pack from $1.99. The tax on other tobacco products was increased to 92 percent of wholesale price, from 41 percent. These changes will increase tax revenues by about $6 million.
• Wisconsin increased the cigarette tax by 75 cents to $2.52 per pack and changed the method of taxing moist snuff. These changes will increase revenues by about $170 million each year.
• Wyoming changed its method for taxing moist snuff tobacco, basing it on net weight. This is expected to generate about $820,000 in new tax revenues each year.

Other Taxes and Fees

• Arkansas changed the way the severance tax on natural gas is calculated, to be phased in over four years, for a revenue increase of $74 million in fiscal year 2009.
• California temporarily increased vehicle license fees to 1.15 percent of the vehicle’s value from 0.65 percent, raising about $1.7 billion in new revenues each year in fiscal years 2010 and 2011.
• Colorado raised several fees, fines, and surcharges to support transportation improvements and instituted a $2 per day rental car fee. These changes will generate about $250 million in new state revenues in fiscal year 2010 within the Transportation Fund. Additionally, a motor vehicle fee to support local emergency services was increased to $2 from $1.
• Connecticut increased environmental fees and placed a conveyance tax on foreclosed properties, for an increase of almost $90 million.
• Delaware temporarily reinstated the estate tax.
• Florida increased a variety of fees and licenses, including court- and vehicle-related licenses and fees, raising around $1 billion in new revenues each year.
• Hawaii temporarily increased the motel room tax by 1 percentage point to 9.25 percent. Hawaii also increased the conveyance tax on purchase of large properties and second homes.
• Idaho added fees for driver’s licenses, vehicle title transfers, copying records, and replacing registration stickers. These changes will generate about $23 million in new revenues beginning in fiscal year 2010.
• Maine raised various fees, including vehicle registration fees, for an increase of over $10 million.
• Massachusetts imposed a 5 percent excise tax on satellite broadcast services. This will increase revenues by nearly $26 million in fiscal year 2010. Additionally, Massachusetts increased driver’s license and vehicle registration fees for an $82 million increase in fiscal year 2010.
• Minnesota increased various vehicle related fees and court fees, one of which is temporary, for a revenue increase of over $15 million.
• Nevada temporarily increased the business license fee to $200 from $100 for a $31 million revenue increase. An increase in the hotel tax is expected to raise $110 million.
• New Hampshire increased the excise tax on hotels and meals to 9 percent from 8 percent and extended the tax to campsites, which will increase revenues by about $30 million per year. By temporarily increasing a number of fees related to motor vehicle and trailer registrations, New Hampshire will increase revenues by more than $40 million in fiscal years 2010 and 2011. The state also enacted a new tax on gambling winnings to raise about $8 million a year. Fees charged to insurance agents for obtaining vehicle records were increased, along with fees for vanity license plates. These changes will generate about $5 million per year in new revenues.
• New York increased a variety of fees, including the regulatory fee on public utilities for over $550 million and motor vehicle fees for over $100 million. The state also imposed additional vehicle fees to fund the Metropolitan Transportation Authority.
• Oregon increased the excise tax on gasoline by 6 cents to 30 cents per gallon and raised a range of fees — including on motor vehicle registrations and titles, road assessment, identification cards, and other items. These changes will increase revenues by $290 million in the fiscal 2009-2011 biennium.
• Rhode Island expanded the hours of the video lottery and increased vehicle license fees, raising almost $20 million in revenue.
• Utah increased some motor vehicle fees by $20, which will generate about $53 million per year.
• Vermont increased various fees for a revenue impact of $6 million.
• Wisconsin increased a variety of fees, including fees on securities trading and solid waste disposal, for a total increase of over $100 million.
• Wyoming raised vehicle fees for a revenue increase of nearly $4 million.

APPENDIX 2: Major 2009 Revenue Packages

Many states enacted a combination of measures to help close their fiscal gap in 2009. Some states both increased and decreased major taxes; others increased a series of taxes. The following table summarizes the various provisions from states that enacted revenue changes with a significant effect on state revenues.