Project SAFE

Project SAFE

Project SAFE

U.S. Capitol

During ordinary recessions, states may face large declines in tax revenue and increased demand for state services. Because state governments generally operate under balanced-budget constraints, however, state governments typically cut spending and increase taxes during economic downturns. 

States are already evaluating ways to close their budget gaps, including tax hikes, social service cuts and layoffs. Layoffs and service cuts would make things worse by taking even more money out of the economy at a time when employees and residents are already at their most vulnerable.

States saved in their rainy day funds, but no state’s saving is enough to ride out COVID-19.

State governments could:

Federal-State Tax Base Conformity

States rely on federal law to define their income tax bases. Such federal-state tax base conformity brings many benefits, including that it eases states’ legislative and enforcement burdens and reduces taxpayers’ compliance burdens. But states can deviate or “decouple” from particular federal tax provisions on a case-by-case basis, which allows states to secure the principal advantages of base conformity while retaining significant control over their fiscal systems. Likewise, states can increase their conformity with the federal base. 

When states conform to revenue-raising federal tax provisions, states raise revenue, too. By the same token, when the federal government enacts tax cuts, states that conform with the federal base experience revenue losses.

States legislature should analyze how they conform with the federal tax base.  To maximize their own revenues, states should make sure, at a minimum, that they conform with recent federal revenue-raising provisions, especially

Note that the states could most effectively broaden their state corporate tax base by returning to mandatory worldwide combination.

Likewise, to maximize revenues, states should decouple from federal tax cuts, especially tax cuts meant to ease the current fiscal crisis. Although the federal government can afford to cut taxes now, because the states face significant limits on deficit spending, they cannot. States should therefore decouple from:

Relatedly, states should also consider taxing some of the benefits provided by recently enacted federal tax laws. For example, states should consider taxing: 

Whatever options the states choose to cope with the COVID-19 fiscal crisis, they should be aware of limits imposed by the dormant interstate and foreign Commerce Clauses that prevent states from enacting protectionist tax rules that discriminate against cross-border commerce in comparison to in-state commerce. [Knoll, Mason]

More generally, state legislatures can secure greater control over their revenues by limiting automatic conformity with the federal tax base.  For example, states may: