Catherine Rampell: States are cutting taxes en masse. They soon might regret it.
Richmond Times-Dispatch (VA)
Grave Policy Errors
States around the country are cutting taxes en masse ahead of the midterms. This probably comes as welcome news to Americans who are struggling to afford the rising cost of living and worried about a possible recession.
But it's a bad development - precisely <em>because</em> of inflation and recession risks.
At least 27 states plus the District of Columbia have passed significant tax cuts so far this year, according to a recent tally from the Tax Policy Center's Richard C. Auxier. That's in addition to tax cuts doled out by 29 states and the District in 2021. These states are disproportionately - though not exclusively - red and purple, with some blue ones joining in on the fun.
There are a few reasons why this signifies some grave policy errors. The first is these tax cuts partly are enabled by funds from the 2021 American Rescue Plan (ARP) - President Joe Biden's $1.9 trillion, deficit-financed COVID-19 relief bill. This provides yet more evidence that the package contained significant waste.
The ARP was <em>supposed</em> to help states struggling with budget crunches, and thereby prevent the kind of painful austerity measures (layoffs, reductions in public services) that states undertook a decade ago in the aftermath of the Great Recession. But the pandemic recession looked very different than the Great Recession, and in fact, most state budgets exited the 2020 downturn in pretty good fiscal health.
That was due to a combination of factors, including the distribution of job losses; unusually generous unemployment benefits and other federal programs that helped support consumer spending; and rising property values. States' own tax revenue held up remarkably well, so they didn't need much fiscal help.
But Democratic lawmakers, still fighting the last war, gave out a lot of state aid anyway. And they put the cost on Uncle Sam's credit card.
Congress tried to prevent states from using these funds on tax cuts. For practical and legal reasons, though, this restriction proved hard to enforce. So faced with one-time budget surpluses, a lot of states decided to hand that federal cash over to constituents in the form of tax cuts and rebates.
In sum: Federal Democrats accidentally made it easier for (largely Republican) state politicians to slash taxes ahead of the midterms. The GOP therefore can claim credit for a popular policy change and still blame Democrats for the enormous (federal) cost.
This proved to be a political blunder, as well as an economic one. Again, duh, tax cuts are popular - particularly as Americans are struggling with painful inflation. They want a little extra pocket money.
In California, where Democrats are in charge, political leaders even branded newly passed tax rebates of up to $1,050 as an "inflation relief package." Unfortunately, this kind of policy might <em>worsen</em> inflation, at least if enough states slash taxes at large enough scale simultaneously.
That's because inflation fundamentally is driven by a mismatch between strong demand and still-constrained supply. Giving people more money to spend will further stimulate consumer demand, so these tax cuts will add to upward pricing pressures. The effect might be small, but it still is unhelpful.
It's especially unhelpful in states that are focusing their tax-cutting firepower on gas taxes. Gas tax holidays will encourage more fuel consumption, which perhaps is the market in which demand already most outstrips supply.
Finally, there's the timing question. State-level politicians are trying to jam through their tax cuts before the November election. But for a host of reasons, the risk of recession over the next year is rising. That could leave states more vulnerable to the same kinds of budget crunches they previously have suffered.
Thanks to inflation, states' costs (for construction, for example) already have been rising. And depending on the trajectory that the next recession might take, states' tax revenue could plummet, too.
In such circumstances, states might want a sizable rainy-day fund. This especially is true since Congress might not be willing to offer them much assistance next time around - precisely because of the deteriorating reputation of the ARP and earlier Trump-era COVID fiscal packages.
After watching governors and state legislatures squander some of last year's aid, federal lawmakers might be reluctant to provide more direct transfers to replenish state coffers. Likewise, the 2021 debate over whether expanded unemployment benefits and other safety net programs discouraged Americans from working might reduce political support for the kinds of federal programs that could more indirectly support state tax revenue.
Additionally, as Auxier and the Tax Policy Center noted, some states have supermajority rules that make tax hikes more challenging than tax cuts.
So sure, tax cuts might seem like a popular course of action now, in the months leading up to an election. But soon enough, state policymakers might come to regret them.