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Report Breaks Down How Fiscal Cliff will Affect Rhode Island

Tuesday, November 27, 2012

 

The majority of Rhode Islanders would see their taxes rise if the Congress allows the country to go over the fiscal cliff, according to a report released earlier this month by the Pew Center on the States.

The study, titled The Impact of the Fiscal Cliff on the States, finds that the effects on the states from the fiscal cliff’s different tax and spending provisions vary greatly based on the degree states are tied to the federal tax code and federal spending.

“To understand the full cost and benefits of proposals to address the fiscal cliff, policy makers need to know how federal and state policies are linked,” said Pew project director Anne Stauffer. “The implications for states should be part of the discussion so that problems are not simply shifted from one level of government to another.”

Federal policy makers will very soon be faced with difficult decisions about whether and how to address several expiring tax policies and scheduled spending cuts. This report looks at the categories of policies that make up the fiscal cliff and addresses each of their potential impacts on the states.

Scheduled tax changes account for roughly four-fifths—or $393 billion—of the total amount of the fiscal cliff. Because state tax systems are linked in various ways to the federal tax code, the changes would directly affect tax revenue in nearly all states. If certain federal taxes increase, state revenues in most instances would automatically increase as well:

For at least 25 states and the District of Columbia, lower federal deductions would mean more income being taxed at the state level as well, resulting in higher state tax revenues.

At least 30 states and the District of Columbia would see revenue increases because of tax credits based on federal tax credits that would be reduced.

At least 23 states have adopted federal rules for certain deductions related to business expenses. The scheduled expiration of these provisions would give these states higher taxable corporate income and hence higher tax revenues in the near term.

Thirty-three states would collect more revenue as a result of changes in the estate tax that would take effect at the beginning of 2013.

However, six states allow taxpayers to deduct their federal income taxes from their state taxes. For these states, higher federal taxes would mean a higher state tax deduction, reducing state tax revenues.

The scheduled spending cuts account for $98 billion—or about one-fifth—of the federal budget impact of the fiscal cliff. Over half of this amount is due to sequestration required under the Budget Control Act of 2011. Federal grants to states constitute about one-third of total state revenues, and 18 percent of these grant funds are subject to the sequester. Because states differ in the type and amount of federal grants they receive, their exposure to across-the-board cuts would vary significantly. For example, in 2010, federal grants subject to the current sequester were over 10 percent of South Dakota’s revenue, compared with less than 5 percent of Delaware’s revenue.

Similarly, cuts in federal spending on procurement, salaries and wages would affect state economies in different ways. This type of spending accounts for almost 20 percent of the combined state GDP of Maryland, Virginia and the District of Columbia, compared with just over 1 percent for Delaware. Defense, which is the largest area of federal spending on procurement, salaries and wages, varies widely as well. For instance in 2010, federal defense spending made up almost 15 percent of Hawaii’s GDP, contrasted with only 1 percent of GDP in Oregon and Minnesota.

If the full force of the fiscal cliff is realized, the federal deficit would be reduced by $491 billion. However, the Congressional Budget Office has projected that the entirety of the fiscal cliff would be a major driver of a general economic slowdown in 2013. Such an outcome would likely negate the more specific, separate impacts described in the paper.

“Given the uncertainty about whether any or all of the policies in the fiscal cliff will be addressed temporarily or permanently, it is important to understand that the effects of the different components will vary across states,” said Stauffer.

The Impact of the Fiscal Cliff on the States is the first report from a new Pew project looking at the federal-state fiscal relationship. It will examine the effects of federal spending, tax policy and regulatory decisions on the states to enrich policy debates about long-term fiscal stability at all levels of government.

 

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