United States

Decimated state budgets—tax changes are coming

State tax increases seem inevitable. What should businesses expect?

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States are suffering enormous budget shortfalls because of the pandemic-induced economic downturn. And as they try to find a way forward under laws that require them to balance their respective operating budgets, tax increases seem inevitable. Six months into the pandemic in the United States, it’s not a question of if there will be tax increases and more a matter of what form the increases will take.

“They will need to either raise revenue through taxes, cut spending or some combination of both,” said David Brunori, senior director and state and local tax professional in RSM US LLP’s Washington National Tax office. “Everyone who studies this issue—and we study it a lot—believes that tax revenue will have to be increased to some extent. There is just no other way for states to balance their budgets.”

Brunori joined RSM’s Tax Policy Now to discuss how state and local tax landscapes might change and how businesses should prepare to respond. He estimated that state tax losses over the next two years would total as much as $450 billion, a function of how revenue from most types of state and local taxes has declined.

Retail stores have been shuttered, so sales tax revenue is down. Closures of restaurants and hotels have sent hospitality taxes plummeting. Income tax collections, both personal and business, have declined because there have been less wages and profits to tax.

Moving past the shock of all that red ink involves the search for solutions. Brunori suggested that the political environment in each state will shape potential tax increases. Many states that impose personal income taxes will look to raise rates, he said, particularly on high-income earners.

“We have already seen proposals to do just that in about a dozen states for the upcoming legislative sessions,” Brunori said. “In the 45 states that impose sales taxes, there will almost certainly be attempts to expand the base to include more services and digital goods.”

Brunori believes many states will look to increase tax burdens on businesses—especially traditional C corporations and pass-through entities. And some states will propose new gross receipt taxes.

A gross receipt tax “has dramatic consequences on costs, supply chains, the need for vertical integration and compliance,” he said. “And businesses are going to need to be able to evaluate such changes and be prepared to take the appropriate action.”

For many of those businesses, the prospect of a permanent shift to remote work has tax implications. And the states, in their dire situations, recognize that as well.

“They are looking for ways to entice businesses to locate remote workers in their jurisdictions,” Brunori said. “They are likely to use a variety of state tax incentives to accomplish this. These might include business tax credits, sales tax exemptions for equipment purchases. We think this is going to be a very big deal.”

Watch the full Tax Policy Now episode, and visit RSM’s tax policy webpage for more insights and analysis of tax issues stemming from the economic and public health crises.

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