Federal tax cuts passed into law last week will deliver less of a blow to state revenue than initially expected, officials say.
Days after Congressional Republicans passed the “Tax Cuts and Jobs Act,” state Department of Revenue officials were forecasting a $72 million a year loss in already under-performing state revenue.
Montana’s Legislature met just last month to patch a $227 million hole in a two-year state budget.
However, one week beyond the federal tax cuts, the outlook for state funding is improving. Montana no longer expects to lose $24 million a year in federal royalty payments, Revenue Director Mike Kadas confirmed.
The state had initially feared the royalties would be lost as Congress meets a legal obligation to cut government spending to offset $1.4 trillion in tax cuts. That obligation was suspended the Friday before Christmas for at least one year. Consequently, the loss of state revenue fell to $46 million for 2018.
Supporters of the tax cuts say the impact should be even less. That’s because one source of potential loss, a 20 percent deduction on pass-through income, is now thought to be harmless to all but a handful of state governments.
Montana’s Department of Revenue forecasts the pass-through deduction will take a $29 million annual bite out of state income tax collections.
Pass-through businesses do not pay corporate income tax. Instead, the owner reports business income as personal income on a 1040 tax form. Pass-through businesses include sole proprietorships, limited liability companies, partnerships and small corporations taxed as partnerships. The broad pass-through category includes small start-up businesses, as well as real estate partnerships and farms.
In Montana, pass-through income appears on roughly 381,170 tax returns. Many of those filers have no income to report, but the minority do report significant amounts of income. A 20 percent deduction on their reported income will be felt by the state, Kadas said last week.
The predicted loss became a sticking point for Montana Republicans this week, after analysts at the D.C.-based Tax Foundation concluded that the new pass-through deduction had been written in a way to protect states like Montana that hardwire state income tax collections to terms set by federal income tax law.
In linking to federal tax law, Montana assures that the first 38 lines of the state’s individual income tax forms are identical to federal forms and result in a taxpayer’s federal adjusted gross income being the foundation for what is paid at the state level.
Congress put the new pass-through tax deduction lower on federal forms, beneath the adjusted gross income and thereby avoiding revenue blows to most state governments, the Tax Foundation concluded.
But Montana tax law will still be in need of changing to avoid the $29 million sting of revenue loss to the pass-through deduction, said Ed Caplis, Department of Revenue tax analyst.
State Republicans have been questioning DOR’s assessment. Rep. Jeff Essmann, R-Billings, said it makes no sense that Montana would be one of the few states not shielded by the protections congressional Republicans wrote in the new tax law.
“Why the government, that’s been talking all year about budget cuts that harm the needy, would be pushing this interpretation, that would cost a $40 million loss, mystifies me,” Essmann said.
Congressional Republicans expect that businesses and individuals in Montana will save $735 million on taxes as a result of the cuts. If five percent of that money comes back to state tax rolls as a result of new economic activity, the state should be $35 million better off, Essmann said.
In addition to the individual income tax loss resulting from the pass-through deduction, Corporate income tax cuts are expected to initially cut as much as $18 million from state tax revenue, but slide to a $4.6 million loss in tax year 2021.