When Is a Temporary Tax Increase Really Temporary?

State Representative Peter Buckley is fighting for what he acknowledges is a lost cause in Oregon. He wants to keep state income tax rates the same for 2012 as they were for 2011.

Normally, nothing is easier in a state capitol than defending the status quo. In Oregon this year, though, if lawmakers do nothing, taxes will go down. In 2009, as the recession buffeted Oregon, the legislature enacted a temporary tax increase to help balance the budget. For 2012, part of the personal income tax increase is scheduled to disappear. Buckley feels the state needs the money now as much as it did before. That requires new legislation.

His case is that the problem the tax increases were designed to solve hasn’t gone away. Revenues are once again falling short of the state’s expectations, leading lawmakers to turn to cuts to the state workforce and one-time accounting maneuvers. The only reason the tax increases are expiring now, Buckley argues, is a misjudgment. “We assumed that the recession would not be a prolonged one,” says Buckley, a Democrat who co-chairs the House Ways and Means Committee. “At this point the state economists and others were saying we should be building our way out of this.” It hasn’t turned out that way.

His proposal is to keep the higher income tax rates — which only affect individuals who make at least $125,000 a year and couples who make at least $250,000 — in place for another two years. Since Oregon approved the tax increases in 2009, Republicans skeptical of tax hikes have added seats in the legislature, pulling into a 30-30 tie with Democrats in the House of Representatives. The Oregon Constitution requires a two-thirds legislative vote to raise taxes — and preventing a scheduled decrease counts as an increase. As a result, the votes Buckley needs to pass his bill simply aren’t there.

A common strategy

Since the recession began in December 2007, 13 states have enacted temporary rate increases for either their personal income tax or sales tax — states’ two leading sources of tax revenue ( see chart below ). Far more turned to broad-based tax increases that were at least partially temporary than enacted exclusively permanent increases. Some of these tax increases already have reached their expiration dates. Others will soon.

As a result, the debate in the states is the opposite of the one in Washington. Congress has twice decided to extend the federal payroll tax cut in the last three months and is bracing for a battle over extending the Bush tax cuts later this year. Meanwhile, in several states, the question is whether lawmakers will extend temporary taxes and risk angering voters or let them expire on time and risk throwing their budgets back out of balance.

Like Oregon, most of these states are continuing to feel the effects of the economic downturn in their budgets. Moreover, many of them are confronting long-term budget challenges — especially from rising health care costs — that put revenue at a premium. Because of that, in most of these states, there are calls to continue the taxes. So far, though, tax increases have been extended only in Nevada and New York. Elsewhere, as in Oregon, lawmakers aren’t eager to repeat politically painful battles for higher taxes that they fought just a few years earlier.

Frequent extensions

When states do let the taxes expire, it represents something of a break from past practice. There’s a long history of states approving temporary tax increases to deal with temporary budget problems. There’s an equally long history of states extending those taxes, even after the immediate challenge has passed.

One classic example is a 10 percent tax on alcohol that Pennsylvania imposed in 1936 to pay for damage from a catastrophic flood. The tax continued even after the damage was repaired. It exists to this day — with a rate of 18 percent.

Many states have a similar story of a temporary tax that lasted beyond its scheduled expiration date. North Carolina has been debating the subject for more than a decade now. In 2001, the state raised the sales tax and created a new higher top income tax bracket to help cope with its budget problems. The taxes were scheduled to expire in 2003, but lawmakers extended them, then extended them again. Finally, they let part of the sales tax increase expire in 2006 and made the other part permanent in 2007. But in 2009, with the country in another recession, the state approved new income and sales tax increases that were supposed to last two years. Governor Bev Perdue, a Democrat, tried to get the legislature to extend the sales tax last year, but the Republican majority rejected the idea. Perdue is asking for another temporary sales tax this year.

All of this leaves advocates of lower taxes exasperated. “Folks here in North Carolina have experienced plenty of those broken promises in terms of temporary taxes,” says Brian Balfour, director of policy at the conservative Civitas Institute. “When there’s so much uncertainty in terms of tax rates, that really causes a great deal of harm to the economy.”

The basic reason taxes typically get extended is that states’ needs don’t end on the schedule that policy makers had envisioned. The bulk of the large personal income tax increase that Illinois Governor Pat Quinn signed into law last January is scheduled to expire in 2015. Yet, even with the extra revenue, Illinois still faces a multi-billion dollar backlog of unpaid bills and daunting long-term liabilities. “Even though the statute is clear the tax will ratchet down beginning on January 1, 2015,” says Laurence Msall, president of Illinois’ Civic Federation, “many people talk as though its continuation is inevitable.” It wouldn’t be the first time for Illinois. Lawmakers approved a temporary income tax increase in the late 1980s, then made it permanent in the 1990s.

Double challenge 

Given that history, anti-tax advocates sometimes complain that there’s no such thing as a temporary tax increase. Recent history, though, looks somewhat different. Since 2008, temporary tax increases more often than not have been allowed to lapse on time.

As in North Carolina and Oregon, the biggest reason why is that Republican opponents of the taxes have gained more power. In 2010, New Jersey Governor Chris Christie blocked the Democratic legislature’s efforts to extend a one-year income tax increase on the rich. Last year, Republicans in the California legislature wouldn’t give Governor Jerry Brown the votes he needed to extend tax increases put in place in 2009.

The story, though, hasn’t just been one of Democrats being outgunned by Republicans. In Maryland, the Democratic majority allowed an income tax increase approved in 2008 to lapse (larger permanent tax hikes approved in 2007 remain on the books). In Delaware, where Democrats also are in charge, an income tax increase was supposed to last through 2013, but lawmakers cut off part of the increase early.

These actions reflect the double political challenge that comes with extending tax increases. Supporters not only have to defend higher taxes, but must explain why they’re going back on promises that the taxes would only be temporary. Still, some politicians have been able to cleverly use the expiration dates to their advantage.

In New York late last year, Governor Andrew Cuomo coupled a partial extension of a temporary income tax increase on high-income earners with tax cuts for the middle class. The end result is that the state will collect more revenue than it would have if the taxes had expired, but that everyone will pay lower rates than they did the year before. “What he did was called a tax cut by some people,” says Frank Mauro, executive director of the Fiscal Policy Institute, “and a tax increase by some people.” Kansas Governor Sam Brownback is hoping for a similar maneuver, proposing that the state make a sales tax hike permanent to help pay for income tax cuts.

Still, for now, Cuomo and Brownback are exceptions. Earlier this year, Arizona Governor Jan Brewer became the latest politician to say she wouldn’t ask for an extension of a tax increase, even though she was the leading advocate of the sales tax hike in 2010. Arizona has a budget surplus now, but is projected to have a shortfall of hundreds of millions of dollars in the 2014 fiscal year, after the tax increase expires.

Jon Shure, the director of state fiscal strategies at the liberal Center on Budget and Policy Priorities, argues that the temporary tax increases have been an important way for states to preserve key services over the last few years. Still, as an advocate for higher taxes, he does acknowledge the downside. “It’s possible that making the tax increase temporary will make it easier to enact, but then you have to face the situation when it lapses if you still need revenues. That means having to ask for a tax increase another time and the politics can be difficult,” Shure says. “Having the tax increase be temporary can make it easier to get and harder to keep.”