Bush Tax Plan Could Cost States $4B

CBSNews.com's Jarrett Murphy takes a look at the impact of President Bush's $670 billion tax cut proposal on the states.

The Bush administration tax plan might hold good tidings for investors, but it could be bad news for cash strapped state governments, says a report.

The Center for Budget and Policy Priorities, a liberal policy research organization, finds that the president's proposals for cutting taxes on dividends and small businesses could cost state governments up to $4.3 billion a year.

That at a time when states are facing their worst fiscal crisis since World War II.

The president's $670 billion tax plan calls for eliminating the tax on dividends paid to stockholders, loosening the rules on what expenses small businesses can write off and speeding-up tax cuts already scheduled under the 2001 tax law.

Those accelerated reductions would expand the lowest tax bracket, reduce rates in the top four tax brackets, reduce the marriage penalty and increase the Child Tax Credit.

The White House contends the plan will stimulate the economy by allowing consumers to spend more and encouraging investment, giving the plan the potential to create 2.1 million jobs in the next three years.

Democrats have criticized the proposals for increasing the deficit and favoring wealthy taxpayers.

A Treasury Department analysis shows that 40 percent of the plan's benefits go to people reporting more than $200,000 in annual income. However, the White House contends that the benefits of its plan are in proportion to the share of income taxes borne by wealthy people.

The CBPP report contends that regardless of which taxpayers get a break under the Bush plan, it "provides no fiscal relief for the states."

The reason the tax proposals could hit states hard is that many state income taxes are calculated based on taxable income under federal law. According to CBPP, 37 states and the District of Columbia tax dividend income based on federal definitions.

The Bush tax plan also contains a capital gains break for people who own stocks that do not pay dividends. That would also contribute to loss of state taxes.

Altogether, eliminating the federal tax on dividends would cost states a collective $4 billion a year. California — suffering from a massive budget shortfall — would lose $1.2 billion a year, New York $524 million and Illinois $132 million.

California's budget deficit for the coming fiscal year is projected to reach $35 billion, which is larger than the entire annual budget of the nation of Ireland.

Another six states use their own definition of dividend income, not the federal one. Their taxes would not change automatically, but those states could feel pressure to follow the federal lead. If they did, the cost of the tax plan to states could rise to $4.3 billion a year.

States also would be hit by the president's proposal to allow small businesses to write off more investment expenses, to the tune of $200 million.

The tax plan might also make it costlier for states to borrow money. Eliminating the dividend tax could draw money out of the bond market, causing bond prices to fall and interest rates to rise.

According to the National Governors Association, states are facing their worst fiscal crisis since the 1940s. Collectively, state governments face a $60 billion budget shortfall, the result of declining revenue because of slowing economic growth and increased spending, especially on medical care.

Cities could also be squeezed by the federal tax cuts. New York City, for example, bases its income tax on the federal income tax. The state's Democratic comptroller estimates that over ten years, the Bush plan could cost the city $2 billion in lost taxes and $1.3 billion in higher interest costs.

Report author Iris Law says the impact of tax cuts on state budgets will erase any economic stimulus the president's plan provides.

"When states cut programs, they lay off workers, reduce the extent to which they contract for services, lower benefit payments to individuals, and cut reimbursements to providers," the report concludes. "In other words, the actions states take to balance their budgets contract the economy and cause a loss of jobs."

By Jarrett Murphy