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The State Tax-Cut Movement

By year-end, about half of the states will have cut rates on income within three years.

By The Editorial Board, WSJ

Jan. 30, 2023 6:45 pm ET

Good news for taxpayers, or at least some of you: Statehouses across the country are continuing to cut taxes in a movement that shows no sign of slowing down. By year-end, nearly half of all states will have cut their income-tax rates within a three-year period. The good results so far confirm that we’re in a virtuous economic-political cycle.

At least six states have kicked off their 2023 legislative sessions with income-tax cut proposals. Newly inaugurated Governors in Arkansas and Nebraska campaigned on rate cuts and are asking legislators to follow through. Leaders in Virginia and Montana want to cut rates modestly with bipartisan support. Large GOP majorities in West Virginia and Utah are considering significant cuts after hesitating last year.

Each of these states has at least one neighbor where tax rates have dropped recently, and competition is sustaining the trend. “We were the cool kid on the block 15 years ago when we moved to 5% flat,” said Rusty Cannon, president of the Utah Taxpayers Association, referring to his state’s flat income-tax rate this month. But in the past two years Colorado has adopted a 4.4% top rate on income, and Arizona dropped its rate to 2.5%. “We’re no longer the cool kid on the block at all,” said Mr. Cannon.

The tax-cutting trend took off in 2021 as state revenues boomed, driven by postpandemic reopening, rising stock prices and capital gains, and federal aid. By September 2022, 31 states were outperforming their prepandemic revenue trajectories, according to Pew Research. Twenty-one states have cut their income taxes in this period, according to the Tax Foundation, and they’re betting that returning revenue to taxpayers will spur faster economic growth.

The results so far vindicate these choices. Many states that cut taxes in the early stage of the revenue boom have sustained or expanded their surpluses. That’s what happened in Idaho, which boasts one of the best-performing state budgets according to Pew. In May 2021 Gov. Brad Little cut the top rate on income to 6.5% from 6.93% amid a $900 million surplus. The state’s surplus grew by more than 50% the next year, and Gov. Little followed up by reducing the income tax to a flat 5.8%.

Flat-rate tax reforms are also spreading. Last year Georgia, Iowa, Mississippi and Arizona joined Idaho in enacting one. That brings the nationwide total to 13, after public-employee unions finally won a referendum that nixed Massachusetts’s flat 5% income-tax rate last year. Now the top Bay State rate is 9%, an invitation to move to Nashua, N.H. Flat rates on income help restrain the upward creep of taxes by forcing politicians to raise rates on everyone in order to reach for more revenue.

Tax-cut critics always predict that a revenue bust is around the corner, pointing to disappointing results after Kansas cut taxes in 2012. Yet Governors of late have moved carefully, often cutting less than official revenue estimates would allow.

Leaders in Mississippi and West Virginia rejected optimistic budget projections and opted for more limited cuts than were originally proposed. States such as Iowa and Montana have reduced taxes in phases spread out over years, while rate cuts in states like Kentucky and Indiana kick in only when certain revenue levels are exceeded. These phased cuts blunt the immediate economic benefit of lower rates, but they help allay political fears that budgets will spontaneously combust years after the cuts.

States that don’t cut taxes in times of surplus invariably spend more, often building commitments that are hard to sustain and lead to pressure to raise taxes in the lean economic years. That’s what happened last year in California, where Gov. Gavin Newsom followed a $97 billion surplus with a $300 billion budget, including new climate spending and expanded Medicaid for illegal migrants. This month the state announced a $23 billion deficit.

The tax-cutting spree is increasing the tax divide between GOP-led and progressive Democratic states. This in turn contributes to more cross-state migration. From Florida to Texas and Idaho, the states that draw the most new residents from other states tend to have much lower tax rates. Population losers like New Jersey, New York and California are among the most punitive taxers.

Competition is moving states toward better tax codes, and the trend is compounding. Americans in states that haven’t joined the tax cutters at least have more places to move to.

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