Taxpayers Smacked by State Tax Hikes

New York taxpayers are getting a nasty surprise in the next months, as retroactive tax increases require them to set aside much more money in their quarterly tax payments. The Wall Street Journal reports that this change is hitting taxpayers who have high deductions especially hard.

Those tax hikes were tempting, but this kind of story showcases one of the big problems with raising taxes during a recession: that unstable tax code gives everyone an incentive to earn less and lie more, since they don’t know what they’ll actually get to keep. Instead of spending big during good times and squeezing taxpayers during bad times, states should plan ahead for this kind of crisis.

A better plan is to set aside savings for bad times — New York could have kept spending low during the boom years, paid down debt, and had a large expense cushion when times got more difficult. That might have slowed the boom down a bit (with less hiring going on at city hall, wages citywide would be a tad lower), but that’s not such a big problem: a crash from a Dow at 13,000 or 12,000 is less painful than a crash from 14,000, and if the states didn’t have such high ‘leverage’ in the form of ratcheted-up expenditures, the market might not have dropped so far, either.

This hypothetical story of responsible state spending reads a little like a fairy tale, which just shows how far we’ve fallen. It should be possible for legislators to be responsible — to have spending grow 2% when revenues grow 3%, so taxes won’t have to soar after the inevitable shortfall. Instead, we have a system where swings in the market are exacerbated by optimistic politicians, who convince everyone (including themselves) that the trendline can point straight up forever.

Now, we’re facing the consequences. A taxpayer doing a business tax filing would need to be especially careful here. Since these taxes apply to high incomes with high deductions, sole proprietors and small LLCs are going to be walloped by the tax hikes.