Tracking the Fallout From State Tax Cuts

Kentucky Speaker of the House David Osborne admitted in late May that state Republicans’ plan to eliminate the personal income tax doesn’t add up. He said the General Assembly will abandon its efforts to ratchet down the rate to zero — heeding warnings from the Kentucky Center for Economic Policy and other experts who said the move would lead to political and fiscal disaster.

The personal income tax generates 41 percent of the state’s revenue, but conservatives have been seeking to undermine it for years. In 2022, the legislature passed HB 8, which set in motion a series of phased-in cuts that would cut the state’s 5 percent income tax up to a half point per year. In 2023, they doubled down on the plan, passing a second bill that put into law the goal of eventually eliminating the tax.

With the rate having now fallen to 4 percent, the tax cuts are already costing the state $1.3 billion annually — more than it spends on its entire system of public colleges and universities. Wealthy Kentuckians have seen most of the benefit, with 65 percent of the tax cuts going to the richest 20 percent of people.

With elimination off the table, legislators announced a new target tax rate of 3 percent. In the past, tax-cut proponents have proposed partially offsetting the lost revenue by increasing sales taxes. The state has already expanded the sales tax to some new services, including parking, moving costs, repair services, taxi cabs, and family portraits, to cushion the blow of previous rate cuts. But that expansion was far too modest to replace the massive revenue losses from income tax cuts. All told, the state has now raised only $1 for every $18 lost by moving to a 4 percent income tax.

If lawmakers enacted a larger sales tax in the future, that would hurt working families and worsen inequality. Families with the lowest incomes already pay five times as much as wealthy Kentuckians in sales and excise taxes as a share of their income. Not only would families with low incomes see little to no benefit from cutting the income tax further, they would also end up paying even more for essential items like household products, clothing for their kids, and school supplies.

Ohio Gov. Mike DeWine said that a series of recent tax cuts, which provide an outsized benefit to the wealthy and corporations, are one of the driving factors behind lower-than-projected revenue collections in the state. Revenue is down by roughly half a billion dollars compared to expectations for this point in the year. This is a significant shortfall, equal to more than two years of funding for the state’s need-based college grant program.

Republican members of the state legislature are blaming slowing economic growth for the emerging revenue gap, but that is likely compounding the problem rather than causing it. The more straightforward culprit is a pair of personal income tax cuts passed in 2021 and 2023. The cuts are already costing the state nearly $2 billion in lost revenue each year — roughly double the amount the state spends on its Department of Children and Youth, which provides child care, early learning, adoption and foster care, and child welfare services.

Ohio legislators and governors have been enacting tax cuts that disproportionately benefit the wealthy for the past two decades. Today, the richest 1 percent of Ohioans on average pay $50,000 less in income taxes than they did in 2005, and the most recent income tax cuts reinforced the state’s upside-down tax system. Low-income Ohioans pay more than twice as much of their income in state and local taxes as the richest do.

Legislators’ attacks on the state’s personal income tax have also helped entrench white wealth and influence. White households hold 87 percent of all wealth across the country. Because Ohio’s income tax cuts benefited wealthier households, average benefits were higher for white households than Black households.

Ohio also made a flurry of other costly tax and budget choices last year. Most notably, the state cut its Commercial Activity Tax and removed income limits for its private school voucher program, leading to a spike in enrollment. These changes, which mostly benefit corporations and wealthy families, could exacerbate the state’s revenue shortfalls.

West Virginia temporarily avoided a health care funding crisis after Gov. Jim Justice demanded legislators restore funding for the state’s Medicaid program. Lawmakers initially slashed Medicaid appropriations by $147 million, saying the state faced "fiscal uncertainty” following passage of one of the biggest tax cuts in the country. They reversed course during a special session held this month.

However, the reprieve is likely to be short-lived because the legislature included a provision in the appropriations bill that creates a new funding cliff in March 2025. Nearly 30 percent of West Virginians are enrolled in Medicaid. If the legislature does not maintain appropriations, state officials said they will be forced to cut enrollment, reimbursement rates, or critical services that families use, including prescription drugs, substance use treatment, physical therapy, and disability programs.

This year’s scramble is a harbinger of worse things to come. West Virginia is expected to see major decreases in revenue after enacting a sweeping personal income tax cut that could cost more than $800 million annually starting in 2025. The tax cut law tilted the tax code further toward the wealthy, with the top 20 percent of households receiving nearly $2 out of every $3 in tax cuts. The top 1 percent of filers (those making $467,000 or more) will get around $10,000 apiece, while the bottom 20 percent of filers (those making under $19,000) will receive just $21 per year on average. Meanwhile, the revenue loss could grow over time, because the law includes new triggers that could eventually eliminate the income tax altogether.

If the state continues marching toward income tax elimination, the tax code will only become more lopsided. Phasing out the income tax would also obliterate the state’s main funding stream not only for Medicaid but also for other vital public services, including schools and universities, community health programs, and various anti-poverty efforts.

West Virginia’s tax cuts risk immediate harm and will hamstring the state’s long-term potential by sapping revenues that could have been used to confront challenges such as declining infrastructure or child poverty. For example, lifting all poor West Virginia families with children above the poverty line would cost about half as much as the recent tax cut. 

S&P Global Ratings lowered Mississippi’s credit outlook from stable to negative amid concerns about phased-in tax cuts, slowing revenue growth, and debt held by the state’s pension plan. Mississippi is currently the only state in the country with a negative outlook. But the downgrade sends a warning to other states that have recently made or are considering deep tax cuts.

Mississippi cut personal taxes starting in 2024. This tax cut will result in nearly $2 billion in lost revenue over the next five years. Yet Gov. Tate Reeves has already called for legislators to take further action and entirely eliminate the personal income tax, which generates about 30 percent of the state’s general fund revenue.

Bond ratings determine the cost states pay to borrow for water and transportation projects as well as other infrastructure needs. Lower ratings mean states have to pay higher interest rates. This in turn means states must either spend more to finance infrastructure projects or scale them back.

If Mississippi continues down this fiscally dangerous path and credit agencies downgrade the state’s bond rating, it will cost Mississippi millions more to complete urgently needed infrastructure upgrades. In the capital city of Jackson, for example, 145,000 people still lack reliable, clean drinking water while they wait for improvements to the city’s water system.

It can take years to reverse a bond rating downgrade, creating long-term challenges for states facing overdue investments in communities. For example, it took six years for S&P to raise Louisiana’s bond rating to stable after bad state financial decisions — including tax cuts — led to a downgrade in 2017.

As states’ 2024 legislative sessions continue, several states are beginning to experience the fallout from counterproductive fiscal policy decisions made over the past few years. The combined effects of large tax cuts, costly new school voucher programs, and other factors such as expiring federal fiscal aid are starting to make themselves felt — a trend that’s likely to continue. We’re launching a new CBPP resource, Tracking the Fallout of State Tax Cuts, to trace the impact on public services and the consequences for communities.

Several states are already facing tough choices about adequately funding their existing budgets or seeing some early warning signs about their ability to do so down the road. For example:

• In Arizona, lawmakers are scrambling to address an unexpected budget shortfall and avoid harmful cuts in public services after the state’s massive 2022 tax cuts and significant expansion of its private school voucher program both proved costlier than anticipated.
• In Mississippi, a major credit rating agency cited the state’s 2022 tax cut — the largest in state history — in its recent decision to downgrade the state’s credit outlook. If the negative trend continues and credit agencies take the additional step to downgrade the state’s bond rating, it would cost the state millions in higher interest payments and make it harder for policymakers to access funds for improving roads, schools, water quality, and other long-neglected public assets.
• And in West Virginia, a massive income tax cut enacted last year that’s heavily tilted toward wealthy households is furthering a trend toward austerity budgets. In recent years, underfunding has forced the state to forgo building repairs, leave jobs unfilled in jails and prisons, and lay off faculty and discontinue many degree programs at West Virginia’s flagship public university.

The growing pressure on funding for public services doesn’t come as a surprise. The past three years have seen a historic wave of state tax-cutting, as more than half of the states slashed their income taxes — in some cases by extraordinary amounts, and often accompanied by gimmicks to mask the full cost, such as triggers and phase-ins.

In Kentucky, North Carolina, and West Virginia, mechanisms now in place could eventually eliminate taxes on personal or corporate income altogether, with devastating effects on state services and outsized gains for taxpayers at the very top. The tax-cutting trend has continued into 2024, with Colorado, Georgia, Idaho, Iowa, and Utah having already cut rates this year, a major tax cut in Hawaii currently awaiting the governor’s likely signature, and states such as Arkansas, Kansas, Louisiana, and Oklahoma potentially following.

Many states have gone beyond income tax cuts to layer on additional harm, particularly through a rapid proliferation of private school voucher programs that redirect money away from public schools and toward private schools (often with little accountability) or home-school families. Some others are also considering drastically cutting or even eliminating state and local property taxes, which would fundamentally undermine public funding of public education — a bedrock of our nation’s democratic system.

Meanwhile, the expiration of remaining federal aid for schools will likely put additional strain on state and local education budgets, and other COVID-response fiscal aid that federal policymakers provided for a range of state and local needs is drawing to an end as well.

The combined effects of these forces on state revenues and services are already starting to peek through, and history suggests worse is yet to come. In the decade following the Great Recession of 2007-2009, for example, widespread cuts in state personal and corporate income tax rates led to harms such as sharp increases in public college tuition, cuts in school funding, and a weakening of income supports like unemployment insurance — all of which hurt people and communities and slowed economic recovery.

Our new resource will highlight cases where state decisions to cut or divert revenues are jeopardizing funding for current public services, such as K-12 schools and health care, and preventing states from investing to meet emerging or long-standing needs such as updating aging infrastructure, expanding Medicaid, or reducing families’ child care costs. We’ll also highlight new state tax cut proposals, identify emerging tax policy trends, and show how decisions on tax policy can affect efforts to reduce income inequality, make progress on racial equity, or even protect democracy.

It will take time for the damage from this most recent wave of counterproductive state policy choices to fully emerge, and the specific impacts will vary from state to state. But this resource will strive to capture that story as it unfolds. It will also help policymakers and others understand that tax cuts come with tradeoffs, and that some states have taken a different and better approach: rejecting policies that undermine vital public services in favor of ones that protect and raise revenues to support investments that help all families and communities thrive.