May 1, 2002

PRESERVING STATE REVENUE FROM THE EFFECTS OF RECENT FEDERAL LEGISLATION
States Can "Decouple" from Federal Tax Changes

by Iris J. Lav, Elizabeth McNichol, and Nicholas Johnson

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At a time when states across the country are facing severe budget problems, two recent cuts in federal taxes could exacerbate fiscal stress. The new federal laws could force states to forego tens of billions of dollars in revenues over the next few years. The loss of this revenue would jeopardize spending on a range of state programs, including spending on low-income and human services programs.

States can avert this loss of revenue — and maintain adequate resources to support programs — by "decoupling." Decoupling means protecting the relevant parts of their tax code from the changes in the federal tax code, in most cases by remaining linked to federal law as it existed prior to the change. A number of states already have acted to decouple.

 

What Are the Federal Tax Changes and How Do They Affect States?

Estate Tax

 

Bonus Depreciation

 

How Much Will States Lose?

 

Shouldn't States Go along with These Federal Changes In the Hope That Reducing State Taxes Will Boost the State's Economy?

 

What Can States Do?

Choosing whether to enact a major tax cut such as bonus depreciation or estate tax repeal should be a deliberate decision by a state, not something that is forced on states by federal actions. To the extent that these federal changes are harmful to state fiscal conditions, states can take action to mitigate the harm. Specifically, states can maintain their own estate taxes based on the federal credit prior to repeal, and states can continue to use the regular federal depreciation schedules or make equivalent adjustments.

Effects on States of Estate Tax Repeal and Bonus Depreciation

  Estate Tax Bonus Depreciation
Federal tax change phaseout of federal credit for state estate taxes paid. "bonus depreciation" provision of 2002 economic stimulus legislation
Effective date Credit is phased out over four years, beginning in 2002 bonus is effective retroactive to September 2001 and expires September 2004
Effect on states effectively repeals most state estate taxes reduces state corporate and individual income tax revenue
Potential revenue loss to states $19 billion to $23 billion between fiscal years 2003 and 2007 more than $14 billion between now and September 2004
States that could potentially be affected every state except Oklahoma every state except California, Nevada, Washington, and Wyoming
Will all of these states automatically be affected? no; states whose tax codes are not automatically updated to reflect changes in the federal tax code will not be affected until they update their references to the federal tax code
How states can "decouple" from the federal action change state law so the elimination of the federal estate tax credit does not affect the state estate tax maintain depreciation rules that existed prior to the new bonus depreciation for the period the new federal rules are in effect
States that are decoupled Arkansas, D.C., Kansas, Maine, Maryland, Minnesota, Nebraska, New York, Oregon, Rhode Island, Virginia, Washington, Wisconsin Arkansas, D.C., Georgia, Idaho, Indiana, Iowa, Maryland, Massachusetts, Mississippi, Nebraska, Texas, Virginia

For additional information, including data on the potential revenue loss for each state and details on the specific decoupling steps that states can take, see the following Center reports:

States Can Retain Their Estate Taxes Even as the Federal Estate Tax Is Phased Out, by Elizabeth C. McNichol, Iris J. Lav, and Daniel Tenny, January 31, 2002

States Can Avoid Substantial Revenue Loss by Decoupling from New Federal Tax Provision, by Nicholas Johnson, April 29, 2002

Estimate of Revenue Loss that Can Be Avoided by
Fully Decoupling from Federal Estate Tax Changes
Revenue Loss that Can Be Avoided (millions) Total
State FY 2003 FY 2004 FY 2005 FY 2006 FY 2007 FY 03-07
For States With a Pickup Tax Only
Alabama $15.1 $28.4 $43.4 $56.5 $59.9 $203.3
Alaska 0.7 1.5 2.3 3.1 3.5 11.1
Arizona 18.4 40.8 64.6 86.8 96.3 306.9
Arkansas 6.4 14.3 22.6 30.3 33.7 107.3
California 230.5 510.6 808.0 1,085.7 1,205.1 3,839.9
Colorado 20.4 45.2 71.5 96.0 106.6 339.6
Delaware 10.2 22.5 35.6 47.9 53.2 169.4
District of Columbia 16.9 31.9 48.8 63.6 67.4 228.6
Florida 189.3 419.3 663.6 891.7 989.8 3,153.7
Georgia 31.5 69.7 110.3 148.2 164.5 524.2
Hawaii 4.3 9.6 15.1 20.3 22.6 71.9
Idaho 2.7 6.0 9.5 12.8 14.2 45.2
Illinois 89.1 197.3 312.3 419.6 465.8 1,484.1
Kansas 10.2 22.5 35.6 47.9 53.2 169.4
Maine 7.6 16.7 26.5 35.6 39.5 125.8
Massachusetts 50.2 111.1 175.9 236.3 262.3 835.8
Michigan 51.1 96.2 147.1 191.7 203.3 689.3
Minnesota 13.1 29.0 45.9 61.6 68.4 217.9
Mississippi 6.8 15.1 23.9 32.1 35.6 113.5
Missouri 38.7 85.7 135.6 182.3 202.3 644.6
Montana 2.3 5.1 8.0 10.8 12.0 38.2
Nevada 10.5 23.2 36.8 49.4 54.8 174.7
New Mexico 6.2 13.8 21.9 29.4 32.6 104.0
New York 118.5 341.4 563.9 785.3 915.5 2,724.5
North Carolina 30.4 67.3 106.5 143.1 158.8 506.1
North Dakota 1.3 2.9 4.6 6.2 6.8 21.8
Oregon 10.8 23.9 37.8 50.8 56.4 179.7
Rhode Island 5.4 12.0 19.0 25.6 28.4 90.4
South Carolina 12.1 26.8 42.4 57.0 63.2 201.4
South Dakota 2.1 4.7 7.4 10.0 11.1 35.4
Texas 97.2 191.8 296.5 390.2 420.0 1,395.8
Utah 7.5 16.7 26.4 35.5 39.4 125.4
Vermont 3.1 6.9 11.0 14.8 16.4 52.2
Virginia 30.8 68.3 108.1 145.3 161.3 513.9
Washington 26.4 58.5 92.7 124.5 138.2 440.3
West Virginia 4.3 9.6 15.1 20.3 22.6 71.9
Wisconsin 19.0 42.1 66.6 89.5 99.3 316.6
Wyoming 1.9 4.3 6.8 9.2 10.2 32.5
For States with Their Own Estate or Inheritance Taxes*
Connecticut $36.0 $87.0 $138.0 $192.0 $200.0 $653.0
Indiana 8.5 20.1 24.0 24.5 24.5 101.6
Iowa 15.2 26.1 37.6 44.2 45.6 168.6
Kentucky 15.0 25.0 35.0 45.0 47.7 167.7
Louisiana 8.7 19.5 31.7 43.7 47.6 151.2
Maryland 21.0 42.2 63.2 82.4 87.4 296.2
Nebraska 5.2 13.1 18.3 23.6 25.0 85.2
New Hampshire 6.3 9.4 20.8 27.9 31.0 95.3
New Jersey 51.0 101.0 148.0 190.0 209.0 699.0
Ohio 7.0 18.1 39.7 40.7 43.2 148.8
Oklahoma 0.0 0.0 0.0 0.0 0.0 0.0
Pennsylvania 25.0 35.0 50.0 60.0 63.6 233.6
Tennessee 2.4 5.2 8.3 11.2 12.4 39.5
*All estimates for states with their own tax are provided by the state unless otherwise noted.
Notes: See footnotes to Tables 4A & 4B in States Can Retain Their Estate Taxes Even As The Federal Estate Tax is Phased Out. The states in italics (Arkansas, District of Columbia, Kansas, Maine, Maryland, Minnesota, Nebraska, New York, Oregon, Rhode Island, Virginia, Washington, and Wisconsin) have already decoupled for at least one year and so would not face a revenue loss. See paper for details.

 

Cost to States of Conforming to Bonus Depreciation Rules, By State Fiscal Year (Dollars in Millions)
FY 2002 FY 2003 FY 2004 Total
Alabama $49 $45 $41 $135
Alaska 31 73 52 156
Arizona 48 113 81 242
Arkansas 24 56 40 119
California n/a n/a n/a n/a
Colorado 38 91 65 194
Connecticut 44 104 74 222
Delaware 5 15 15 35
Florida 126 146 124 396
Georgia 78 185 132 394
Hawaii 9 22 15 46
Idaho 14 32 23 69
Illinois 159 378 270 806
Indiana 79 187 134 400
Iowa 14 46 48 108
Kansas 25 59 42 126
Kentucky 32 76 55 163
Louisiana 25 59 42 127
Maine 13 31 22 67
Maryland 52 123 88 262
Massachusetts 118 279 200 597
Michigan 13 51 47 111
Minnesota 104 130 117 351
Mississippi 24 58 41 123
Missouri 38 91 65 195
Montana 10 23 16 48
Nebraska 0 35 32 67
Nevada n/a n/a n/a n/a
New Hampshire 19 44 32 95
New Jersey 116 274 196 586
New Mexico 17 41 29 88
New York 912 545 1,457
North Carolina 86 203 145 434
North Dakota 7 16 12 34
Ohio 39 152 139 330
Oklahoma 21 50 36 107
Oregon 45 106 76 227
Pennsylvania 148 352 252 753
Rhode Island 8 20 14 42
South Carolina 25 60 43 129
South Dakota 3 8 6 17
Tennessee 48 113 81 242
Texas 198 279 253 730
Utah 19 45 32 97
Vermont 3 14 8 25
Virginia 60 143 102 305
Washington n/a n/a n/a n/a
West Virginia 16 35 21 72
Wisconsin 62 146 104 312
Wyoming n/a n/a n/a n/a
New York City 170 403 288 860
District of Columbia 35 32 29 96

Notes: n/a = Not applicable.
States in italics (Arkansas, Georgia, Idaho, Indiana, Iowa, Massachusetts, Mississippi, Nebraska, Texas, Virginia and the District of Columbia) are now decoupled from federal bonus depreciation provision and therefore not expected to be affected by revenue loss.