Tax cuts remain a powerful tool to entice people and firms, and the pandemic has triggered a new tax war. After the lockdowns, states and cities predicted unprecedented revenue drops. Instead, economies bounced back quickly from the pandemic, partly because of widespread adoption of remote work and extensive federal aid from the Trump and Biden administrations — hundreds of billions of dollars in unemployment benefits (which kept individuals spending money), business loans and funding for local governments to fight COVID-19.
The March 2021 Biden stimulus then provided local governments with an unprecedented $350 billion to bolster their budgets. The revenue gusher has produced state budget surpluses where experts had only recently predicted steep deficits.
Nearly a dozen states, mostly Republican-governed, have used the windfall to cut taxes. Idaho reduced its corporate and individual tax rates and shrank its income-tax brackets from seven to five, producing a $163 million tax cut for residents and businesses. The state also sent $220 million in rebates to everyone who filed tax returns in 2019.
Advocates for higher taxes often say that the levies don’t drive away wealthy individuals or businesses. When New Jersey raised taxes on the wealthy in November 2020, Democratic Gov. Phil Murphy said, “When people say folks are going to leave, there’s no research anywhere that suggests that happens.”
Yet New Jersey, with taxes on the wealthy and on businesses long ranking among the nation’s highest, ranked a dismal 42nd in economic growth over the five years preceding the pandemic, according to one study, and it has been an economic laggard for two decades. Voters in this overwhelmingly Democratic state showed their disapproval in giving incumbent Murphy an extremely narrow victory in his November reelection bid. Polls showed that most voters favored the Republican position on cutting taxes over Murphy’s.
The past year has been a fiscal nightmare for Nashville. Covid-19 helped punch a $332 million hole in the city’s $2.46 billion budget. Tennessee state comptroller Justin Wilson warned that, without drastic action, the state might take over management of Nashville’s affairs. In response, the city council raised property taxes 34 percent, spurring a citizen revolt in the form of a ballot initiative to overturn the tax hike. Without the extra revenue, however, Mayor John Cooper’s administration said that drastic cuts would be unavoidable: “Few corners of the Metro government, including emergency services and schools, would be spared significant reductions or eliminations.”
Nashville’s budget woes predate the pandemic: the city began borrowing money to cover deficits after the Great Recession of 2008–09. City leaders, at the same time, went into heavy debt to build new government-owned attractions, offered workers health retirement benefits that they haven’t funded, and deep-sixed pension reforms that saved the state billions of dollars. In fact, back in December 2019, the state comptroller issued a similar warning to Nashville about its shaky finances.
The Music City isn’t alone. The Covid health emergency and accompanying economic downturn caused budget crises for municipalities—cities, counties, and school districts—across America. A February letter from 400 mayors to President Biden said that the pandemic-inflicted strain on municipal budgets had “resulted in budget cuts, service reductions, and job losses” throughout local government. America’s largest city, New York, grappled with a nearly $10 billion budget deficit in the spring of 2020, while Chicago struggled with a $2 billion gap. Dozens of local governments used the crisis to justify budget maneuvers that fiscal experts generally frown upon, from borrowing money to close deficits to issuing bonds to fund employee pensions.
The Biden administration will need practically every Democratic representative in Congress to vote for its proposed $2 trillion package of tax increases, which would be the largest in 54 years. To gain that support, the president may have to season his legislation with some SALT. The bill, which raises corporate taxes and boosts capital-gains levies, among other things, doesn’t restore the full federal deduction for state and local taxes that Donald Trump’s 2017 tax-cut bill capped.
Democrats in key high-tax blue states, including New York representative Tom Suozzi and New Jersey representative Josh Gottheimer, have been complaining that Trump’s tax bill placed an undue burden on their states’ residents. Some have vowed not to support any tax legislation unless it reinstates the full SALT deduction. The problem: federal data show that restoring the deduction would overwhelmingly profit rich taxpayers—and lawmakers in many blue states have already raised their own levies on the rich.
Subsequent data have shown that the SALT changes fall heavily on the rich, while the vast majority of taxpayers in high-tax states have benefited from the Trump cuts. An analysis of 2018 New York tax returns found that the number of residents subject to the higher rates of the Alternative Minimum Tax declined to just 0.2 percent of all returns, down from 5.9 percent in 2017. Thanks to the doubling of the standard deduction, the number of New Yorkers itemizing their deductions shrank by nearly two-thirds that year, according to an Empire Center report. A recent report by the left-of-center Brookings Institution found that 57 percent of the benefits of restoring a full SALT deduction would go to the top 1 percent of households, providing them with an average tax cut of $33,000.
Five Washington communities—Spokane, Yakima, Spokane Valley, Granger, and Battle Ground—have passed resolutions in recent weeks pledging to outlaw income taxes at the local level if the state adopts income or capital gains taxes. More jurisdictions are promising to follow suit. Local officials are intent on sending the state a message. “Small businesses are the backbone of our local, regional, state, and national economy and it is imperative that the city not put unnecessary hurdles in the way of their success,” Battle Ground’s resolution declared. “Citizens want good government that is fiscally responsible,” Republican state representative Chris Corry argued at a hearing in Yakima. “Putting an income tax ban locally shows a commitment to being fiscally responsible.”
Washington lacks an income tax thanks to a 1932 state Supreme Court ruling that interpreted the state constitution as prohibiting the levy. Over the years, voters have rejected ten attempts to amend the constitution to institute an income tax. The last vote was in 2010, when nearly 65 percent of voters gave a thumbs-down to a ballot initiative heavily supported by the state’s public-sector unions and Bill Gates Sr. (Then-Microsoft CEO Steve Ballmer and Amazon founder Jeff Bezos helped lead the opposition.)
Watch a recording of Truth in Accounting’s virtual event with special guest Steve Malanga, senior editor at City Journal. In this episode, we discussed the financial troubles of America’s largest cities and the effects of Biden’s infrastructure plan.
Author(s): Bill Bergman, Sheila Weinberg, Steve Malanga
Like many cities, Nashville is also in hock to pensioners, with $4.3 billion in unfunded promises for retiree healthcare. And though Nashville’s pension system is well-funded, it is also expensive to maintain because employees contribute almost nothing, leaving taxpayers on the hook for about $110 million in annual contributions—and potentially more when investments tank. Despite the burden, the city resisted adopting reforms the state enacted in 2013, when Tennessee switched to a pension plan that requires employees to contribute 5% of their wages.
Nashville’s balance sheet wasn’t in any shape to endure a massive pandemic hit. Led by a 50% decline in tourism, the city’s economy slumped last spring, and unemployment soared above 15%. That punched a $332 million hole in the fiscal 2021 budget, prompting then-Tennessee Comptroller Justin Wilson to warn in September of a state takeover. The city could become “kind of like a teenager coming to their parent asking for $20 to go to the movies,” he said.
The New York tax burden is already punishing enough. New Yorkers pay a greater percentage of their earnings to the state than residents of any other state. The total tax burden, on top of federal taxes, amounts to 12.79 percent of income, according to a new study. Opponents of the latest tax increases claim that the state’s punishing rates are responsible for driving high earners and businesses away, and indeed the state consistently faced massive levels of net outmigration to other states even before the pandemic. That migration has included thousands of jobs in areas like financial services. Among the firms that have relocated significant jobs away from the city are Credit Suisse, Barclays, UBS, and AllianceBernstein, according to a recent Forbes article. Goldman Sachs has moved a big-money management division to Florida, and hedge fund manager Carl Icahn has decamped there as well. The Empire State’s taxes are one reason that former hedge fund manager Leon Cooperman said, “I suspect Florida will soon rival New York as a finance hub.”
After decades of expert predictions that technological change would reshape the nature of employment, in just ten months the Covid-19 economic shutdowns have made full-time corporate employment from home a reality for tens of millions of American workers. Just how many of these workers will remain employed at home after the pandemic ends remains an open question, but it’s clear that many workers have become convinced that there’s little reason to go back to the old model of everyone in the office all the time. In a Gallup poll in the initial stages of the shutdown last April, 46 percent of workers said that they were working full-time out of their homes. Millions have since gone back to the office, but 33 percent of respondents told Gallup that they were still working from home last fall. More to the point, about a third of all those who worked remotely told Gallup that they would like to do so permanently, even after the pandemic. In another poll, taken by the consulting firm PricewaterhouseCoopers, 29 percent of workers said that they wanted to work permanently from home.