The last two years were a good time to make state fiscal policy. Booming revenue collections combined with hundreds of billions of dollars from Congress in pandemic-related aid have pushed tough budget decisions off the agenda in most states.
In fact, 29 states passed major tax cuts in 2021 and 35 states did so in 2022, even as most states significantly increased spending and replenished rainy day funds. However, policymakers still face trade-offs when they cut taxes during extraordinary fiscal times.
In a new report, we look at five states—Connecticut, Delaware, Mississippi, Utah, and Vermont—that lowered individual income tax rates, expanded tax credits, or sent one-time refunds in 2022. We studied each using the Model Tax Policy of State income tax for the Center.
As some states consider another round of tax cuts in 2023, here are three lessons from 2022.
Income tax rate cuts benefit households with a large amount of taxable income
In the 11 states that lowered individual income tax rates in 2022, the largest direct benefits went to higher-income households. That’s because the benefits of a tax rate reduction are relative to a household’s tax bill. For example, this is what happened when Mississippi created a single tax and lowered the rate from 5 percent to 4 percent. (That rate reduction is scheduled to occur over three years, but we model it as taking effect immediately to simplify cross-state comparisons in the report.)
That is, Mississippi households making more than $100,000 got thousands of dollars in average annual tax breaks because they pay tens of thousands of dollars in state income taxes each year. (Note: the unit of analysis is a tax unit; we use “households” throughout this post for simplicity.)
By contrast, a household that pays little or no income taxes gets little or no benefit from a rate cut. This group primarily includes low-income households, but may also include retirees. For example, about one in five Mississippi households earning between $50,000 and $75,000 in adjusted gross income did not get any benefit from the tax rate reduction, most likely because they receive Social Security benefits, pensions, and other types of income from retirement that are taxable. exempt in Mississippi.
If the goal of lawmakers is to boost economic growth, a rate cut could help, although calculating fiscal growth is more complicated than that. But a rate cut by itself won’t do much for working families. To do that, a state would have to create or extend a refundable tax credit.
Specific tax cuts produce specific benefits
Connecticut expanded its Earned Income Tax Credit (EITC) and Vermont created a Child Tax Credit (CTC) for low-income households with children under age 6. Because both credits are refundable, they benefited households with little or no taxable income.
In 2022, 10 states created or expanded an EITC or CTC. While benefits and eligibility rules varied, each of these states gave a large tax cut to specific households, mostly low-income households with children, while capping costs of entry. However, this also meant that many households did not see any benefit.
For example, while a CTC-eligible family in Vermont got an average annual tax break of more than $1,000, only one in ten households earning less than $100,000 was eligible. Similarly, while a state EITC (based on federal eligibility rules) is more widely available and can provide hundreds of dollars in tax relief to working families, only benefiting about a quarter to a third of all low-income households.
By contrast, Delaware sent one-time tax refunds to all filers, and tax rate reductions in Mississippi and Utah reached a larger proportion of households.
Good times don’t last forever, but your tax cut could
Delaware passed a big tax cut in 2022. The cost of about $220 million equaled 4 percent of its Fiscal Year 2022 General Fund Revenues. But because it was a one-time refund, it won’t affect future budget decisions. Say what you want about the tax refunds, but Delaware and the 17 other states that sent them in 2022 coincided with a potential single tax time with a single tax cut.
Meanwhile, Mississippi’s tax cut was large (7 percent of its Fiscal Year 2022 General Fund Revenues) and permanent. Income tax rate reductions don’t have to cost states a lot of revenue (Utah’s was relatively small), but new or expanded refundable tax credits, like those in Connecticut and Vermont, generally cost a lot. less than tax rate cuts.
While fears of a recession persist, state finances remain mostly strong as lawmakers gather in state capitols to craft new budgets. As such, states that lower income tax rates in 2021 or 2022 could consider refundable credits that help households that didn’t benefit from previous tax cuts, and states that passed one-time refunds could consider tax relief. permanently fiscally responsible.
But at some point, perhaps soon, the economy will turn, and the states that have passed larger permanent tax cuts will face tougher tax decisions because of those tax cuts. If and when that happens, they need to remember what taxes they cut and who they benefited in that new budget environment.
