NEW YORK – In response to a second year of exceptional revenue growth, major tax policy changes under consideration or already enacted by several states – including Oklahoma, which was slashing budgets less than a decade ago – could have negative long-term credit implications if current revenue growth is not sustained, Fitch Ratings says.
The permanence of tax policy changes and their links to revenue triggers, as well as evolving macroeconomic conditions, could have crucial implications for long-term credit risks, Fitch contends.
Tax proposals for 2022 are more ambitious than the first round of tax cuts in 2021, which focused mainly on personal and corporate income taxes. The latest proposals involve a broader mix of taxes on gasoline, property, investment income, sales, as well as PIT and CIT.
Robust collections and large surpluses projected for fiscal 2022 (ending June 30 for most states, including Oklahoma) provide an accommodative, but potentially short-lived backdrop for tax cuts, Fitch notes.
Notoriously volatile corporate and business tax revenues are a key driver of current surpluses, the ratings company points out. Revenue growth will slow as economic growth moderates in 2022. Rising inflation and interest rates raise the possibility revenue trends could reverse if economic conditions rapidly deteriorate.
Fitch distinguishes among temporary tax “holidays,” permanent tax cuts implemented gradually, and permanent tax cuts that take effect immediately.
Tax holidays ranging between two months and one year are the focus of a majority of the 40 states that either are considering or have passed tax cuts this year. The revenue implications would be limited for those states – such as Alaska, Connecticut, Illinois, Maryland and Pennsylvania – where tax holidays are the primary tax change.
Some states are considering multipronged tax changes. For example, Georgia has implemented a two-month gas-tax holiday and provided a one-time $1 billion personal income tax refund from fiscal 2021 surpluses. The state also is considering a more expansive and permanent compression of all personal income tax rates to a single flat rate.
Fitch views permanent and immediate cuts as the riskiest to credit. Substantial tax policy changes can negatively affect revenues and lead to long-term structural budget challenges, especially when enacted all at once in an uncertain economic environment, Fitch warns.
Oklahoma, Idaho, Kansas, New Mexico, Michigan and Virginia have all either enacted, or are considering, permanent tax cuts.
Measures introduced in the Oklahoma Legislature have included proposed cuts to the franchise tax and the motor vehicle tax, change the personal income tax to a flat tax, and varied proposals pertaining to the state sales tax on groceries.
In the 1990s the late Jim Hamilton, a Poteau Democrat who served as chairman of the House Appropriations and Budget Committee for eight years, advised his colleagues that when the state was flush with cash the Legislature should authorize temporary tax rebates rather than approve permanent tax cuts. The economy is cyclical and State Question 640, a constitutional amendment Oklahomans approved in 1992, made it almost impossible for the Legislature to raise state taxes, he explained.
Hamilton was prescient. State government was in dire financial straits after four consecutive years of budget shortfalls that collectively mounted to $3 billion, and repeated declarations of state government revenue failures, before the Oklahoma Legislature reluctantly approved multiple tax increases and imposed caps on several tax deductions and tax credits in 2017 – a quarter-century after enactment of SQ 640.
New Mexico legislators propose to eliminate taxes on Social Security income and reduce the state gross receipts tax rate. Missouri lawmakers want to cut the personal income tax, repeal the corporate income tax, and lower the sales tax on groceries.
Several states, including Arkansas, Indiana, Iowa, Kentucky, Minnesota, Nebraska, Ohio and South Carolina, are pursuing a series of cuts to be phased in over several years, often linked to year-over-year revenue growth-rate triggers that must be met for successive phases to take effect, which could help temper revenue declines.
However, Iowa’s adopted cuts do not include revenue triggers, while Kentucky’s triggers are tied to governmental fund revenue benchmarks that will be easier to reach than annual revenue growth targets. In both cases, the phased-in cuts are a sizable percentage of general fund budgets, and weak or absent revenue triggers are more likely into translate to dramatically slower revenue growth or absolute revenue declines, Fitch advises.