SALT Legislative Outlook, Trends And Predictions For 2012

In examining what to expect in the coming year, we again consider the threshold question that we have posed for the last several years but remains relevant – is it possible for the states and localities to somehow manage to avoid fiscal catastrophe without fundamentally altering their tax base or spending requirements? In 2011, with a slowly recovering economy, the landscape began to change for the better in some states, but not in others. Instead of practically all states facing fiscal nightmares, a chasm has begun to grow between states that will continue to have significant trouble meeting their obligations, and states that will be well-prepared for whatever the future brings. Many states will continue to face difficult fiscal situations over the next several years because of structural deficits, intractable political wrangling in the state legislative and executive branches, and other factors. On the other hand, a select number of states are in comparatively good fiscal shape because they hold significant natural resources and/or maintain good fiscal discipline.

States in fiscal trouble will likely continue to mine their existing tax systems for additional untapped sources of revenue, while considering groundbreaking changes to these systems, like alternative corporate tax regimes, broader imposition of the sales tax on growing sectors of the economy (including services and technology), and more progressive individual income taxes. In contrast, the more fiscally responsible states can afford to consider providing more beneficent tax treatment, including the potential for tax cuts, in an effort to spur local economic growth. Regarding existing costs, states are somewhat hamstrung by what they can do, as they uniformly have made significant cuts to services in the past several years. Restructuring pension costs to lower current and future expenses are a likely strategy, and the well-positioned states are more likely to be able to figure out palatable methods to make these changes on the fly.

Another option to balancing budgets may be to reduce the amount of direct aid the states provide to localities. However, many localities are dealing with fundamental fiscal problems of their own, and pushing down costs may only exacerbate these issues. From the local government level, continued weakness in the real estate market is eroding the property tax base, which along with the pressures of pension, health care and other fixed costs is likely to threaten the fiscal health of jurisdictions that cannot restructure their budgets through other sources of revenue or elimination of "nonessential" service costs.

On the revenue side of the ledger, localities may be forced to supplement their lagging property tax and sales tax receipts with additional local gross receipts taxes. On the expense side, cutting services will be tough, especially if states try to push their own costs onto localities' balance sheets. Many localities that are unable to bridge the gap may have to consider the "worst-case scenario," claiming bankruptcy under Chapter 9 of the U.S. Bankruptcy Code.1 In 2011, Jefferson County, Alabama, and Harrisburg, Pennsylvania were the most prominent municipalities to claim Chapter 9 bankruptcy protection, and we would not be surprised in the least if more Chapter 9 cases arise this year.

With the broad state and local fiscal landscape in mind, significant changes to state and local tax structures are inevitable. In this alert, we briefly look back to see whether, and to what extent, the predictions that we made at the beginning of 2011 verified. Then, we consider what may happen in the state and local tax world in 2012.

2011 Predictions – A Review

Decoupling from federal 100 percent bonus depreciation provision. Specifically, we predicted that once legislatures had a full opportunity to consider the federal 100 percent bonus depreciation provision during 2011, at least three%quarters of the states ultimately would decouple from this provision. While approximately two thirds of the states ultimately maintained their opposition to bonus depreciation, this prediction fell a little short. Pennsylvania2 and Illinois,3 two states which historically had decoupled from bonus depreciation, unexpectedly conformed to the federal provision due to quirks in their statutes which were not amended. Reevaluation of gross receipts and margin taxes. We predicted that one state would seriously consider a shift from a corporate income tax to a gross receipts tax, while Michigan would substantially modify or eliminate the modified gross receipts tax portion of the Michigan Business Tax (MBT). Michigan did, in fact, eliminate the modified gross receipts tax by converting to the Michigan corporation income tax.4 As for shifting to a gross receipts tax, Nevada, a state that currently does not have a corporate income tax, briefly considered, and then rejected, a margin tax akin to the Revised Texas Franchise Tax (RTFT). A second year in a row without a move to combined reporting. We predicted...