States Mull Pros and Cons Of New Federal Tax Law

By Joetta L. Sack — June 04, 2003 4 min read

While Democrats and Republicans in Congress squabble over the potential effects of the newly enacted federal tax cuts, state leaders are expressing gratitude for the $20 billion in state aid the tax package contains.

But most analysts say that while the amount may look significant to hard-pressed states, the money is not likely to have a large impact on education budgets. Some even caution that the tax measure—signed by President Bush last week—could have some unintended negative consequences for state budgets overall.

The state aid includes a $10 billion federal contribution to state and local governments over the next two years, as well as another $10 billion for Medicaid expenses, which have been among states’ fastest-growing costs. The money will be doled out on a population-based formula.

“The $20 billion is definitely a help,” said Nicholas W. Jenny, a senior policy analyst at the Nelson A. Rockefeller Institute of Government in Albany, N.Y., which is the public-policy-research arm of the State University of New York.

He added, however, that “it’s not going to completely solve the problems in any state.”

And David L. Shreve, a senior director for education policy with the National Conference of State Legislatures, based in Denver, noted that the money comes with strings attached—and that some of those stipulations could restrict the allocation of funds for K-12 expenses.

“Not that we’re not happy with this,” he said, “but when you start divvying up the money amongst states, then divvying it up among all the programs screaming for funds, it looks less and less significant.”

For starters, Mr. Shreve said, states likely will not be allowed to use the $10 billion in unspecified funding to supplement federal programs, unless those programs were so-called unfunded mandates.

Technically, costly education requirements such as those in the “No Child Left Behind Act” of 2001 and the Individuals with Disabilities Education Act are not unfunded mandates, he pointed out.

A provision of the tax-cut law would, though, let states use the money for “essential services,” he said. “Most states would probably define education and special education as essential,” he added.

Still, even if states allocated all of the $10 billion to K-12 education, it would hardly affect state and local education budgets, which total about $400 billion annually, Mr. Shreve said.

Consequences Debated

The National Governors Association, meanwhile, was happy to see the allotment.

“Governors appreciate that the administration and Congress recognize the importance of the fiscal condition of the states,” Gov. Dick Kempthorne of Idaho, a Republican and the vice chairman of the NGA, said in a statement. “These monies will help governors continue to provide essential and critical services to our citizens.”

The measure, which totals $350 billion in short-term federal tax cuts, will reduce taxes on capital gains and stock dividends, provide income-tax relief, and give businesses more deductions. The bill passed the House, 231-200, on May 23; it passed the Senate, 51-50, the next day, with Vice President Dick Cheney casting the tie-breaking vote.

Nearly all Republicans voted in favor of the measure, which was a top priority for the Bush administration. President Bush is betting that the tax package will spur more investments by businesses and individuals, which could help create hundreds of thousands of new jobs and revitalize the listless economy.

Most Democrats vehemently opposed the bill. They argued that it would balloon the federal deficit to record levels, while only the wealthiest taxpayers would see any significant tax relief. They also criticized “sunset” provisions that they see as gimmicks masking the likely longer-term extent of the cuts.

Some Republicans, also reluctant to increase the budget deficit, had to be persuaded to back the bill. One of them, Sen. George V. Voinovich, a former governor of Ohio, insisted that the total package be kept to $350 billion, instead of the more than $700 billion in tax cuts that President Bush had initially requested.

“I’ve pushed for as big a tax cut as possible and also for keeping the total deficit cost of the package to $350 billion,” Sen. Voinovich said in a statement after the measure passed the Senate. “The final version ... will provide a needed shot in the arm for the economy right now.”

Some experts, though, worry that the new tax breaks could adversely affect states, at least in the short term.

Michael Griffith, a policy analyst with the Denver-based Education Commission of the States, cautioned that many states tie their own income-tax rates to the federal levels and so will see their gains from the state-aid package countered by declines in state tax revenue.

“States that are very reliant on income tax are likely to be hurt a lot,” Mr. Griffith said. They include cash-strapped California and Oregon.

California already has a budget deficit estimated at $38 billion over the remainder of fiscal 2003 and through fiscal 2004, out of an $80 billion annual budget. It will receive about $2.4 billion from the tax-cut plan, according to the state’s finance department. Oregon is slated to get $216.5 million, a state official there said.

Proponents of the tax cuts have argued that the cuts will spur the economy and thus help raise state revenues. Mr. Griffith said that such gains, though, were not likely to come within the next few months.

“In the short term, because these tax cuts are retroactive, it seems pretty unlikely we are going to turn the corner economically in the next few months,” he said.

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