Income Tax Relief and Related Reforms Continue to Surge

More States Are Cutting Individual Income Tax Rates

At some point, this trend will affect sales tax rates (in fact, we may have reached that point, as I’ll explain in a moment). 

The Tax Foundation reports that 22 states have cut top marginal individual income tax rates since 2021. While income tax reductions surged during 2021 and 2022, many tax policy experts expected states to ease off the tax-relief gas pedal this year. However, “those expectations have been shattered,” according to the Tax Foundation’s Katherine Loughead in her analysis of pro-growth tax reforms U.S. states have ratified so far this year.

These measures extend beyond income tax reductions to corporate income tax reductions, sales tax reductions (which two states – New Mexico and South Dakota -- have implemented in the past 24 months), capital stock tax repeals, the adoption of permanent full expensing rules, raising nonresident filing and withholding thresholds, improving the treatment of business tangible property and related actions. This year, 14 states have enacted one or more of those tax relief measures; plus, more than a half-dozen states are still considering these types of reforms.  

Loughead Points to a Couple of Drivers of This Trend

First, many states have enjoyed significant revenue growth in the past two years, portions of which were driven by federal stimulus money. This has helped replenish pandemic-stricken budgets coffers and rainy-day funds. Second, state “lawmakers are increasingly attuned to the value of tax competitiveness in an ever more mobile economy,” Loughead notes. “With businesses and individuals alike better positioned than ever to take taxes into account in deciding where to live and work, lawmakers across the country are responding with pro-growth, pro-taxpayer reforms.” 

How long state reserves remain flush is another question, of course. As is the question of how state and local jurisdictions will make up for personal income tax reductions, corporate income tax cuts and other sources of tax revenue declines, including states’ growing use of sales tax exemptions (e.g., a gas tax holiday).  

One approach is to increase local sales tax rates and/or create new sales taxes at the city and district level. Vertex’s 2023 Mid-Year Sales Tax Rates and Rules Report shows that nearly twice as many new district taxes were enacted during the first five months of 2023 (100) compared to the same period in 2022 (54). The number of new taxing cities is also rising sharply — 37 new taxing cities appeared during the first half of this year, a 68% increase over the same period in 2022. 

Tax Rate Cuts Are Usually Welcome News

That said, reductions enacted to achieve one objective (competing for businesses and highly paid professionals) can have unintended consequences (higher sales tax rates at local levels and additional sales tax compliance complexity) when the big picture is not fully considered.