The majority of states will be able to absorb the impact on their revenue if they cut taxes this year, even if they face a mild recession next year, but a small number of states with more wide-ranging tax reduction packages could see budgetary pressure, according to a new report.
The report, released Monday by Fitch Ratings, found that a total of 31 states adopted tax cuts in some form during the 2022 legislative sessions. That represented a significant increase over the 18 states that cut taxes last year. Fitch anticipates the combination of rate decreases, tax holidays and tax exemptions ratified by states will mean short-term revenue losses and a slowdown in the pace of revenue growth in a number of states. On the other hand, Fitch expects the collective revenue effects will be small compared to the overall size of the budgets for most states that cut taxes this year.
"Faster population growth generally translates into more rapid growth in tax collections, which will help states with more rapid population growth to better withstand the revenue declines, or in some cases slowdowns in the pace of new revenue formation, associated with tax cuts," said Fitch Ratings director Michael D'Arcy, in a statement.
That's good news for states such as South Carolina and Idaho experiencing rapid population growth. But Iowa and Nebraska would face more risk in a severe downturn and could be forced to turn to reserves as a "bridging measure" to absorb shortfalls until the economy recovers. That's because Iowa and Nebraska have enacted several rounds of tax reductions since 2020 and their populations are growing at a rate below the U.S. average.
In contrast, Idaho and South Carolina, which have also passed sizable tax cuts that don't include revenue triggers or other guardrails, may fare better thanks to their strong job markets and quickly growing populations. Over the long term, Fitch anticipates that some states' tax plans could limit their recurring revenue growth because of the size of the tax reductions, their back-loaded timetables and structural components such as moving to a flat income tax or complete elimination of the personal income tax.
Economic conditions remain particularly uncertain, the report noted, due to an unusual combination of high inflation and tightening monetary policy, against the backdrop of a strong labor market and continued consumer spending.
