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:

• Use their rainy-day funds aggressively. [Gamage, Shobe]
• Repeal or modify statutory balanced-budget rules, which restrict deficit spending. [Gamage, Shanske]
• Relax restrictions on local government revenue-raising and borrowing. [Gamage, Jurow Kleiman, Scharff, Shanske]
• Expand Medicaid (for states that have not already done so). [Gamage]
• Impose new taxes, including
  • excess profits taxes [Avi-Yonah]; for revenue estimates contact Marian
  • mark-to-market taxes on certain forms of wealth or unrealized capital gains [Marian]
  • other taxes on wealthy individuals and businesses that are suffering less from the downturn. [Gamage, Shanske]
• Reform wealth taxes by imposing either real property surtaxes on their wealthiest residents or partial deemed realization of the unrealized capital gains of the very wealthy. [Gamage, Shanske]
•  Expand state sales tax bases, through
  • digital-services taxes, which must be formulated carefully to avoid legal problems [Livingston, Mason, Mazur, Shanske, Thimmesch]
  • broad-based advertising taxes [Mason, Shanske, Thimmesch]
  • new broad-based consumption taxes. [Livingston, Shanske, Thimmesch]
  • taxes on services consumed primarily by households, rather than businesses. [Gamage, Nielsen, Shanske, Shobe]
• Increase property tax revenue while protecting the most vulnerable by empowering localities to adjust property tax rates, providing targeted property tax relief, reforming rules to reduce home foreclosures, and modifying public disclosure requirements. [Hayashi, Jurow Kleiman]
• Borrow to fund essential services. Such borrowing likely would not be constrained by borrowing limitation rules and state constitutional constraints. [Gamage, Shanske]
• Reform state corporate income taxes by taxing the I.R.C. 965 repatriation, conforming to GILTI, adding a temporary income tax surcharge, suspending tax credits, reforming the location of sales, and expanding the corporate income tax to include all large businesses. [Avi-Yonah, Gamage, Shanske]
• Reform unemployment insurance by removing obstacles to claiming benefits and creatively expand benefit eligibility [Galle, Gamage, Scharff, Shanske]

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

• Global Intangible Low-Taxed Income or “GILTI”. For some data on potential revenue gain, see here. [Gamage, Shanske]
• Deemed repatriation of foreign earnings under I.R.C. 965. [Gamage, Shanske]

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:

• Section 168(k) additional first year depreciation deduction. [Gamage, Shanske, Thimmesch]   
• Section 199A deduction introduced in the 2017 TCJA. [Gamage, Shanske, Thimmesch]
• The corporate tax cuts provided in the CARES Act, including several changes made to Sections 163, 170, and 172 [Gamage, Livingston, Thimmesch] and the temporary suspension of Sec. 461(l) [Wallace]
• Double tax benefit created by the federal allowance of an exclusion for forgiven PPP loans plus deduction of the expenses those loans funded. [Thimmesch]
• CARES Act changes to the Section 163(j) limitation on new business interest deductions. [Gamage, Shanske, Thimmesch]

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

• the 199A windfall. [Shanske]
• retroactive refunds from CARES Act relief, such as the elimination of 461(l). [Marian]

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:

• Switch to static (from dynamic) conformity. [Mason, Livingston, Thimmesch] 
• Consider selective conformity. [Gamage, Livingston]