Tax and Budget

As most states in the Midwest entered a new fiscal year in July, the unknowns about FY 2021, and beyond, far outweighed the knowns. Will more federal assistance be made available to help close budget shortfalls? How big will those shortfalls be? Will the economic effects of the COVID-19 pandemic be felt the entire fiscal year?

“It’s been very hard for states to forecast given the uncertainty of the public health emergency,” Shelby Kerns, executive director of the National Association of State Budget Officers, said during a July webinar of The Council of State Governments’ Midwestern Legislative Conference.

But she told legislators of one unmistakable fiscal reality: “States will be grappling with the impact of COVID-19 for years to come.”

The options to fix out-of-balance budgets fall into three broad categories: cut spending, raise more revenue or tap into savings. But some of the specific strategies traditionally used by legislators may not be available this time around. “What’s different about this fiscal crisis is the public health emergency, which can limit or change some of the options,” Kerns said. “In addition to increased spending being required to respond to the pandemic, some cuts may be impossible, or least unwise.”

Three recent national studies underscore the strength of state economies, fiscal conditions and revenue collections entering the new legislative year in the Midwest. Data from the Urban Institute, for example, compares state tax collections between the third quarters of 2019 and 2018 (July to October) — for every state in the region, revenue was up, and North Dakota was one of eight U.S. states with year-over-year increases of 7.5 percent or more. Nebraska and Wisconsin also experienced significant revenue gains.

Income tax relief is coming to residents in at least two Midwestern states this biennium, while in a third state, legislators took the first step this year toward a major tax overhaul. In Wisconsin, under AB 56 and AB 251, rate reductions are being made to the state’s bottom two income-tax brackets. (Wisconsin’s graduated system has four tax brackets.)

The Supreme Court’s holding in North Carolina Department of Revenue v. Kimberley Rice Kaestner 1992 Family Trust is narrow, precise, and unanimous. The presence of in-state beneficiaries alone does not allow a state to tax undistributed trust income where the beneficiaries have no right to demand that income and may never receive it.

The Kimberley Rice Kaestner trust is governed by New York law and its trustee is a New York resident who has “absolute discretion” to distribute the trust. When the trustees, Kimberley Rice Kaestner and her children, lived in North Carolina the state taxed the income of the trust even though no funds were distributed during the time period. The trust sued North Carolina seeking the $1.3 million it paid in taxes. The trust argued that the tax violated the Due Process Clause of the Fourteenth Amendment.  

Indiana Gov. Eric Holcomb signed a sweeping gambling expansion into law in May, legalizing sports betting at the state’s casinos and “racinos” (racetracks with casino games), as well as on mobile devices.

As Washington State Department of Licensing v. Cougar Den illustrates, not all 5-4 Supreme Court cases involve high-profile, controversial issues where the Justices are divided on ideological lines.

In this case the Supreme Court held 5-4 that a treaty forbids the State of Washington from imposing a tax upon members of the Yakama Nation that import fuel.

An 1855 treaty between the United States and the Yakama Nation reserves to the Yamakas “the right, in common with the citizens of the United States, to travel upon all public highways.” A Washington statute taxes fuel importers who bring large quantities of fuel into the state by ground transportation. Cougar Den is a wholesale fuel importer owned by a Yakama member that transports fuel by truck from Oregon to Yakama-owned gas stations in Washington. Cougar Den argued the treaty preempted the tax.

This case would have been a lot more interesting had it gone the other way. In an unanimous decision the Supreme Court held in Dawson v. Steager that West Virginia violated a federal statute by taxing all the retirement benefits of former federal law enforcement employees but not certain state law enforcement employees.

4 U.S.C. § 111 allows states to tax the pay of federal employees only “if the taxation does not discriminate . . . because of the source of the pay or compensation.” James Dawson, a former U.S. Marshal, sued West Virginia alleging it violated this statute because it taxed his pension but not the pensions of certain state law enforcement employees. The West Virginia Supreme Court found no discrimination because relatively few state employees received the tax break and the statute’s intent was to benefit those state retirees not harm federal retirees.