Annual legislative sessions have wrapped up, and taxpayers have once again gained ground.
Republican-led states are slashing tax rates. But others are giving special handouts to benefit specific industries.
A nnual legislative sessions have wrapped up, and taxpayers have once again gained ground: For the fourth year in a row, budget surpluses have prompted many states to cut taxes. Unfortunately, the quality of tax cuts has varied — from broad pro-growth rate cuts in some states to narrow special-interest breaks in others.
Republican-led states have focused on cutting individual- and corporate-income taxes, which is the best way to spur investment and job creation. According to the upcoming Cato Institute Governors’ Report Card, between 2021 and 2024, 14 states cut their corporate-tax rates and 21 states reduced their top individual-income-tax rates.
Some of the largest income-tax cuts were in Arizona, Arkansas, Georgia, Idaho, Iowa, Mississippi, Montana, Nebraska, Oklahoma, South Carolina, and West Virginia. Republican governor Kim Reynolds slashed Iowa’s corporate-tax rate from 9.8 percent to 5.5 percent, and she chopped the individual-income tax from a nine-bracket system with a top rate of 8.98 percent to a simple, 3.8 percent flat tax.
Some state leaders are talking about phasing out income taxes entirely. That may sound radical, but a diverse group of nine states — including Florida, New Hampshire, South Dakota, and Tennessee — prosper without individual-income taxes. Sales taxes are a simpler and more efficient way to fund state governments than income taxes.
Unfortunately, cutting rates is not the only tax-policy change sweeping the country. State tax systems are increasingly infested with narrow breaks or subsidies as politicians intervene to aid supposedly trendy industries, such as “green” energy, semiconductors, film production, and artificial-intelligence-server farms.
New York has a tax credit for digital-gaming businesses, Virginia has a tax credit for vineyards, California has a tax credit for cannabis businesses, and Georgia hands out $1 billion a year in tax credits for the film industry. These breaks — often called “incentives” — complicate tax codes, distort the economy, and are ultimately unfair to businesses that pay the full tax load.
The Council for Community and Economic Research estimates that there are over 2,400 state business-incentive programs, roughly half of which are tax breaks and the others are spending subsidies. The number of such programs has more than doubled since 2000. For example, Virginia has 92 business-incentive programs, and half of them have been added since 2010.
This type of cronyism in state tax codes is worsening, but the federal government deserves some blame. When Congress passes special-interest breaks, the states enact copycat versions. For example, more than half the states have enacted versions of the federal low-income housing credit, which is a complex and wasteful handout to housing developers that causes problems.
The expansion of green-energy breaks in the 2022 Inflation Reduction Act is mimicked in state tax codes, and at least a dozen states enacted special breaks for semiconductor technology after Congress passed subsidies for that industry in 2022. Special-interest breaks for businesses plague state tax systems because of the unfairness and inefficiency, but politicians keep promoting them to be seen creating jobs in popular industries.
The good news is that the general interest has often triumphed over special interests since 2021 — about half of the states have enacting broad-based rate cuts that benefit everyone. These cuts create a positive dynamic that helps to inoculate states against narrow breaks. You can see this with the strong statistical correlation between scores on Tax Foundation’s state “business tax climate” index and the number of special-interest incentives in a state, as measured by the Council for Community and Economic Research. States with worse tax climates — including high rates — enact more incentives.
Politicians in high-tax states such as New York know that their business climate is awful, so they pose as job creators by giving corporations special breaks to build new facilities. But politicians in low-tax states such as New Hampshire know that they do not need to dish out narrow breaks because their economies boom without them.
Republican governor Sarah Huckabee Sanders slashed Arkansas’s individual-income-tax rate from 4.9 percent to 3.9 percent and the corporate rate from 5.3 percent to 4.3 percent. When signing a round of tax cuts in June, she said, “Arkansans are looking at Washington and seeing nothing but failure. . . . Today they can look at Little Rock and get some of their economic confidence back.” Leaders like Sanders give us confidence that some politicians are putting the general interest ahead of special interests — at least on tax policy.