SALT Legislative Outlook, Trends And Predictions For 2013

With significant shifts in the political composition of state legislatures as well as uncertainty about the effect of the "fiscal cliff" and the amount of funding that will be available from federal sources, 2013 promises to be a year in which states consider innovative, and potentially dramatic, changes to their state tax systems.

We begin with some thoughts on the federal "fiscal cliff," which we initially considered a few weeks back in our SALT Alert summarizing the Top SALT Stories of 2012.1 The well-publicized backpedal off the "fiscal cliff" from a federal income tax perspective at the turn of the new year contains an extension of income tax cuts in effect since 2001 for all taxpayers except for single filers earning more than $400,000 and joint filers earning more than $450,000.2 In addition, phase outs of personal exemptions and itemized deductions will be reinstated for high-income taxpayers.3 For those who track SALT developments, this result is not surprising, as in recent years, a number of states have implemented increased tax rates for high-income taxpayers, along with restrictions on personal exemptions and itemized deductions in certain cases. The economic impact of these effective tax increases, when combined with the failure to extend a temporary 2 percent cut in the payroll tax, could be significant, potentially leading to downward pressure on state sales taxes as consumption declines.

On the corporate income tax side, many provisions were extended for an additional year, including the application of 50 percent bonus depreciation and Section 179 expensing provisions.4 For states, the extension of these provisions for another year is not likely to be treated in a significantly different manner than in the past several years. The states that have typically decoupled from these provisions are likely to continue to do so, and the states that have automatically conformed to these provisions are unlikely to affirmatively make a change. However, Pennsylvania5 and Illinois6 are examples of states likely to alter their treatment of bonus depreciation from full conformity in late 2011 and 2012 (pursuant to 100 percent bonus depreciation, as a result of a technical issue in their bonus depreciation statutes) to full decoupling in 2013.

The resolution of the "fiscal cliff" provides some level of certainty with respect to the federal income tax structure. However, it leaves open the issue of what federal expenditures will be reduced, either through the sequestration process scheduled to begin in early spring, or through other means. That raises some interesting questions for the states, which will need to deal with uncertainty in the amount of funding they will receive from the federal government in the future, including Medicaid and the advent of a new national health care system.7 One would think that states will have to be very conservative in their budgeting process as long as the federal funding question remains, even though a couple of years of slow, steady economic growth and substantial federal funding have helped many states balance their budgets, and in some cases, enter 2013 in a surplus position.8 While some states may be in a position right now to cut tax rates, replenish rainy day funds, or pay bills for burgeoning and potentially uncontrollable expenses like Medicaid, state pension costs, other entitlement programs and education, it remains to be seen how long this will last. At least the threat of the states requesting a wholesale bailout from the federal government appears to have declined for the moment, though that could change if the federal government substantially slashes financial aid for the states in the next few months.

While the federal framework is vital in understanding how states will deal with their budget issues, the composition of each state legislature and executive branch is also important and will drive what types of state tax reforms ultimately occur from state to state. As a result of the 2012 elections, many states are going to have one-party control of state government, with majority (and in some cases, supermajority) margins in the legislatures aligned with governors who may be willing to consider state tax reforms.9 The question that will arise in these states is whether the opportunity for state tax reform can be realized in just a few short months (for example, substantial changes to the overall state tax structure, modifications in tax rates or composition of the sales tax base). In the alternative, will such supermajorities fail to enact state tax reforms, either because of the perception that nothing really needs to be changed, or because the supermajorities are too difficult to manage, falling upon their own weight and leading to discord, gridlock and extended legislative sessions? With so many states controlled by one party, it will be fascinating to watch which states, if any, will succeed in radically changing their state tax systems.

With this background, we review our 2012 predictions made in last year's outlook Alert and then consider what 2013 might bring from a SALT perspective.

2012 Predictions - A Review

Federal legislation on states' rights to impose remote seller collection requirements will not be adopted in 2012, although signs point to adoption in 2013. We predicted that a hybrid version of the three bills10 ultimately would be considered, but would not pass the House this year, though important developments would occur in 2012 laying the groundwork for adoption in 2013. Our prediction on where the remote seller sales and use tax bills would stand at the end of 2012 was verified. The amount of attention on this issue by Congress, in the form of hearings during the last twelve months has been significant, and the prospects for Congress to finally coalesce around one bill for adoption in 2013 are better than they were a year ago. State legislative frenzy...