Letting the Federal Bush Tax Cuts Expire May Have Negative Revenue Consequences in Missouri

When I was driving into work yesterday, I heard a story on NPR reporting that the decision of whether to extend the Bush tax cuts or let them expire is a significant topic of discussion in Washington.

In an article on the Missouri Watchdog, Brian Hook links to a new study from Tax Foundation. It concludes that letting the Bush tax cuts expire would negatively affect revenues for states that allow residents to deduct the amount that they pay in federal income taxes — which includes Missouri. This is because if the tax cuts expire, a high-earning individual living in Missouri would pay more in federal taxes. He or she could therefore deduct more from state income taxes, and Missouri would receive less revenue.

I want to highlight my statements in the article regarding the marginal effects of this policy in Missouri, because it’s a concept fit for Show-Me Daily. From the article:

If the tax cuts are allowed to expire, taxpayers in Missouri will experience higher tax rates, said Christine Harbin, an analyst with the Show-Me Institute, a free market think tank. The top marginal effective tax rates on income would increase to 46.69 percent under the Democrat’s plan, or 41.13 percent under the Republican’s plan.

“Because they will experience reductions in their take-home income, it’s likely that fewer individuals and businesses will decide to come to Missouri to conduct business,” Harbin told Missouri Watchdog.

“People tend to think on the margin, and a marginal number of individuals and businesses will elect to go to other states where the cost of doing business is lower. For those individuals and businesses that do remain in Missouri, this reduction in net income will mean that they will have less money to save or spend.”

The tax policy will also likely have negative consequences for the state budget as well, Harbin said.

“A reduction in general revenue collections will mean that the state will have to raise tax rates further, cut expenditures or borrow more to cover the shortfall,” she said, adding changes in tax policy could further discourage individuals and companies from remaining in Missouri or relocating to the state.

It’s additionally notable that the expiration would negatively affect all taxpayers, not just those in the highest marginal income bracket, because the Bush tax cuts reduced marginal income tax rates for all earners. The Bush tax cuts introduced a new 10-percent bracket; previous to this, the lowest rate was 15 percent. If the Bush tax cuts expire, low- and middle-income earners would also experience a tax increase.

I hope that this reduction in state tax revenues doesn’t lead to the unfortunate consequence of eliminating federal deductibility in Missouri. Contributors to Show-Me Daily have discussed the negative consequences of income taxation before.

If the tax cuts were extended, individuals living in Missouri would be better off because they could keep a greater share of their income, and the state government in Missouri wouldn’t experience a consequent reduction of revenue.