Tax collections were lower than expected in Massachusetts, Rhode Island and Connecticut, leaving the states scrambling to minimize the damage to their budgets. New England isn’t alone in state taxation troubles. The National Association of State Budget Officers reported last fall that 25 states had collections below their budget forecasts in the 2016 fiscal year and 24 reported lower-than-estimated general fund revenues for 2017.
A number of factors could be contributing to the state budget imbalance. One factor could be the economy. As a whole, the country’s economic improvement since the Great Recession has been slow, with an annual growth rate of around 2 percent. States may have been overconfident that under a new presidential administration, spending would increase, and the sales tax, corporate tax and income tax revenue would grow. Results from the first quarter of 2017 paint a more temperate economic outlook.
The May 26, 2017 real gross domestic product (GDP) estimate came in at .7 percent growth, which means that economic growth for 2017 appears to be about the same as it was in 2016. Nonresidential fixed investment and personal consumption increased. Imports and exports, perhaps bolstered by the strength in the value of the dollar, increased during the first quarter as well. Corporate profits, however, were less than stellar. After increases in the fourth quarter, current production and profits from domestic corporations decreased in the first quarter. Lower corporate profits mean lower tax collections for state and local governments.
Increased cost for regulations and government-funded programs may also be a contributor to the unbalanced balance sheet. Rhode Island reported significantly more Medicaid costs than predicted in 2016.
Whatever the cause, businesses should monitor their state’s budget conversations and take care with their tax reporting obligations. When tax collections dip, some states may turn to tax increases and compliance efforts to fill in the gaps. Struggling budgets may mean changes to state and local tax rates as well as more scrutiny on sales and use tax, unclaimed property, apportionment factors and other facets of state and local tax reporting.
Massachusetts State Tax Status
Projections for state tax collections are typically made in the previous fiscal year. Massachusetts predicted that tax revenue would increase by 4.3 percent in the 2016 fiscal year, but quickly lowered its expectations to 3.1 percent after a lackluster second half to 2016. Actual collections appear to be much lower. As of the end of April, state tax revenues had only increased by 1.1 percent, which left Massachusetts with a $462 million budget deficit.
Weak sales tax performance is chief among the culprits, but income tax returns also came in lower than anticipated. Income tax makes up one of the largest sources of state tax revenue.
Massachusetts is planning to release a state budget that would raise revenue to cover the shortage by collecting fees on vacation rental businesses such as Airbnb. A proposed Massachusetts Senate budget would also change how the state collects online sales tax. The state is also considering collecting tax from online hotel resellers such as Expedia for the full amount customers paid for a room.
Rhode Island State Tax Status
Rhode Island reported a $60.1 million shortfall in its 2016-2017 budget year and may be short as much as $39.5 million in the following year. Some of the blame rests with corporate tax proceeds, which may be decreasing by nearly $11 million. Sales tax is also coming in lower than expected.
There’s no clear answer for why Rhode Island’s projections were so far off the mark, but the economy and spending by other state departments appear to be the chief culprits. Rhode Island spending on social programs, including Medicaid, came in $15 million more than expected.
The Rhode Island General Assembly tried to pass its 2017-2018 Budget on the last day of June but a dispute between the House and the Senate at the last minute left the passage in question. The House abruptly adjourned, stating its work was done and leaving the Senate with legislation that it wanted to amend. It is unclear how this matter will ultimately be resolved. If it remains in dispute, Rhode Island will operate under the current budget parameters rather than go through a government shutdown as has happened in many other states. If it is eventually settled, the proposed 2017-2018 budget would pass without broad based tax increases.
To address the budget deficit, Rhode Island cut spending in several areas. The state made a number of adjustments to tax practices. It will be making more of an aggressive attempt to collect sales tax on online purchases by requiring retailers to report its sales to Rhode Island residents to the state. Adjustments were also made to corporate estimated taxes. Currently, Rhode Island companies make 60 percent of their estimated taxes in the first quarter and 40 percent in the second quarter. In 2018, companies will start paying 25 percent of their estimated taxes per quarter. The Division of Taxation will offer a new tax amnesty program to allow the settlement of past-due taxes without penalties and a 25 percent reduction in interest assessments.
The earned income tax credit will also increase from 12.5 to 15 percent. Minimum wage was increased by $.50 for 2018, with a $.40 increase scheduled for 2019.
Connecticut State Tax Status
Connecticut will be roughly $400 million short in income tax collections for the 2017 fiscal year. Declines in income tax collections contributed to the decrease, in part due to poor investment performance. Many of the state’s top earners work for hedge funds, and returns were not as high as anticipated. Sales tax proceeds also came up short. Another factor coming into play could be the exodus of top performing businesses. Higher taxes on individuals and businesses contributed to GE’s announcement to relocate its headquarters from Connecticut to Boston. Aetna recently announced it is considering a move out of Connecticut as well.
The state is considering several options to raise more revenue. One proposal would be to add a surcharge on the earnings of hedge fund managers. Governor Dan Malloy is firmly against additional taxes on the investment industry. Lawmakers may also increase the top rate for the state income tax, which is how the state addressed budget shortfalls in the past. Connecticut’s House of Representatives recently approved a bill to let municipalities adjust their property taxes to make up for the gaps in state assistance that will likely be coming as a result of Connecticut’s budget shortfall.
What Struggling State Budgets Mean for Taxpayers
When tax revenue is lower than anticipated, states may turn to other means of raising money. Increases in tax rates may be a possibility, but enforcement efforts may be used to make up the difference as well. Taxpayers should carefully evaluate their state and local tax reporting to ensure they are meeting their requirements. Proactive reviews should help ensure that no matter how a state responds to fiscal uncertainty, companies will be prepared for the increased scrutiny.
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