High tax rates ≠ high revenues
Lower tax rates incentivize economic activity and therefore expand the tax base. High tax rates do the opposite
Yesterday, my colleague Bill Walsh asked: “Are state tax cuts possible with new federal stimulus bill?” Senate amendments to the American Rescue Plan Act prohibit the use of any of the $350 billion in State and Local Fiscal Recovery Funds to cut taxes, but there are also concerns that states which accept the funds could be prohibited from implementing tax cuts between now and 2024.
Is that the case? Jared Walczak of the Tax Foundation says that: “It’s complicated, but state policymakers have reason to be concerned.”
If the federal government is dishing out money it is not unreasonable for it to attach some strings – he who pays the piper, and all that. The concern here is that the broad language the bill uses about indirect funding of tax relief could also block tax reforms which aren’t reliant on the American Rescue Plan for funding. The relevant passage reads:
“A State or territory shall not use the funds provided under this section or transferred pursuant to section 603(c)(4) to either directly or indirectly offset a reduction in the net tax revenue of such State or territory resulting from a change in law, regulation, or administrative interpretation during the covered period that reduces any tax (by providing for a reduction in a rate, a rebate, a deduction, a credit, or otherwise) or delays the imposition of any tax or tax increase.”
Walczak looks at five possible tax reform scenarios and asks if they are consistent with the American Rescue Plan. It is alarming how quickly we run into trouble.
He finds that a scenario where state “rate cuts are funded either by a commensurate spending reduction or by capturing revenue growth” is consistent with the bill. But, if “State rate cuts are provided for in a balanced manner—using revenue offsets, capturing growth, or making spending cuts—but the state used Recovery Funds to pay public health officers,” it might not be. [Emphasis added] Likewise, the eminently possible scenario where “A state accepts aid in 2021, sees substantial revenue growth, and cuts taxes in 2023” could also fall foul of the bill.
This last point is especially important. In 2022, Minnesota will hold elections for Governor, Senate, and House, among others. It is possible that those elections will be won by a party or parties that run on a platform of reducing taxes. But once in office they may not be able to, legally, because of the provisions of the of the so-called ‘Covid Relief Bill’. Walczak calls this “an astonishing level of federal interference in states’ fiscal affairs” and he is right. If these provisions stand, Minnesota’s next governor and legislature might be elected with their hands already tied.
John Phelan is an economist at the Center of the American Experiment.