Tax Break

Blue states lose: how avoiding the U.S. fiscal cliff hits some states harder than others

December 20, 2012

Democratic-voting blue states could face a greater economic fallout from any fiscal cliff resolution than their Republican red state brethren, according to a Dec. 17 white paper  from municipal bond research firm eBooleant Consulting.

Entitled “The Blue State Tax Crunch,”  the paper predicts a recession for these states even if a broad, country-wide recession is avoided.

Size is one problem. Any changes made to the federal tax code  to try to avoid the cliff will be felt most in the largest states. They already contribute the most to federal taxes and the majority of these big states are blue. Higher tax rates will have an impact.

The 10 largest states together contribute 60 percent of all federal taxes. Seven of the 10 are reliably Democratic: California, New York, Illinois, Pennsylvania, New Jersey, Massachusetts and Minnesota. Only one, Texas, is Republican red. The swing states of Ohio and Florida round out the top 10.

Blue states are also the largest users of itemized deductions, so if capping or eliminating those is part of the federal solution, that will also bring more pain to large, blue states. California, New York, New Jersey and Illinois alone account for 30 percent of all itemized deductions, the paper noted. 

Many large, blue states already have high tax rates. Because most state tax codes are tied to the federal code, any increase in federal tax rates is likely to prompt a jump in the state rates too, hitting residents with a double tax hike. The top marginal effective income tax rate in two reliably Democratic states, California and New York, could climb more than 50 percent, according to the study. 

That adds up to bad news for the blues, the report concludes:

The economies of large, already high tax, blue states are particularly vulnerable to the macroeconomic consequences of fixing the federal fiscal cliff. Depending on exactly how taxes are increased, we may well be headed for a blue credit crunch.

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