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States Reaping Budget Benefits Of Ending Bush Tax Cuts For Richest Americans

The big takeaway is taxes matter, especially tax rates for the richest Americans.

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Across the country, state budget writers are on firmer ground as 2014 begins because Congress raised taxes on investments and the richest Americans when they compromised over the now-forgotten “fiscal cliff” standoff in late 2012.  

In recent weeks, national news organizations have reported that governors and legislators in blue and red states are jockeying over how to spend better-than-expected revenues. In ultra-red Kansas and deep-blue New York, governors on opposite ends of the spectrum want to expand early childhood education. In Democrat-majority California, Gov. Jerry Brown is looking at a putting extra cash into a rainy day fund while legislators want schools and safety nets restored. In other states, the recovery has led to calls for more spending on job training, public health, cheaper higher education, roads and tax cuts.

The reasons for the better-than-expected revenues are a mix of factors: higher income tax revenues, growing sales tax revenues, and conservative budget forecasting—prompting the press reports that revenue forecasts are being exceeded. But where reporters generally stop explaining what’s behind the revenue surge is noting that 2013’s big bump in state revenues—5.7 percent nationally—mostly came from ending some Bush-era tax cuts for the wealthiest Americans and Wall Street investments.

It’s easy to forget the political fight over whether the Bush administration cuts should be kept or allowed to lapse, since the House GOP subsequently allowed across-the-board cuts to take place—the sequester—and then in October forced a federal shutdown. Yet congressional Republicans compromised with the White House in late December 2012 and passed a bill raising income tax rates for the top bracket from 35 percent to 39.6 percent, starting in 2013. The rate on longterm capital gains was raised from 15 percent to 20 percent for incomes in the highest income tax bracket, which is 39.6 percent. Also, a 3.8 percent surcharge was added to unearned income—investments—and an additional 0.9 percent was imposed for individuals making more than $200,000 and couples earning more than $250,000.

These tax changes prompted a lot of wealthy people to move their money around in many tax-avoiding ways, as accountants advised at that time. Their response may have led to some of last years big stock market gains, the Wall Street Journal recently suggested. However, there was no avoiding larger income tax bills for many well-off people last year, because most state income taxes are calculated as a percentage of what's owed to the federal government. State revenue from those assets fell somewhat last year, experts said, but did not disappear entirely 2014’s revenue estimates. (Because federal and state fiscal years do not overlap with the calendar year, the biggest revenue bump was felt the first year the Bush tax cuts ended—2013.)    

Some states are especially dependent on taxes from investment income, such as California, New York, Connecticut and Minnesota. In California, Gov. Brown emphasized this point when he used a chart illustrating fluctuations in capital gains revenue as he unveiled his latest budget in early January, saying that California needed a bigger rainy day fund. Since then the stock market has fallen, which strengthens Brown’s call for a bigger reserve. If he is re-elected this fall, as most analysts expect, and he boosts state reserves, Brown would have billions more to work with in his final term.  

Most states rely on income and sales tax for about two-thirds of their revenue. Income taxes account for slightly more than a third of revenues in the 45 states that have state income taxes, according to the National Association of State Budget Officers. Typically, states calculate their income tax levy as a percentage of the federal tax paid, which is how state coffers swelled in 2013.