In response to a Senate vote in favor of a small reduction in the personal income tax rate and the gross receipts tax on electricity, we pointed out that this is not the right time to be reducing taxes in Pennsylvania.
At the moment, the state has a substantial budget surplus of more than $13 billion—but we need that surplus for two purposes. First, we are currently using it to pay the state’s operating expenses and will continue to do so because annual expenditures exceed annual revenues by more than $3 billion.
Second, the state has serious needs that require additional investment. To start with, we will eventually need an additional $6–$7 billion per year to meet the constitutional and moral responsibility to adequately and equitably fund K–12 education. And then there are critical needs in both pre-K and higher education and workforce training, transportation infrastructure (including public transit), and environmental protection.
So, we believe that the best fiscal policy right now is to add modest new tax revenues as we gradually run down the accumulated $14 billion surplus. Adding sources of revenue now will extend the life of the surplus, putting off the day when even more tax revenue is needed. And, with continued economic growth, it is possible that higher revenues generated by existing and new taxes would enable us to avoid a moment of crisis when we would have to choose between large substantial budget cuts or substantial new revenues.
However, neither party appears ready to start dealing with the coming fiscal crisis this year. And Senate Republicans might insist on some tax reduction in exchange for supporting the critical education funding we must pass this year.
If we do cut taxes, should we adopt the Senate Republican plan?
We do not think the Senate Republican plan is a good idea for two reasons.
First, we believe that any tax cut should provide far more relief for low- and moderate-income Pennsylvanians than wealthier Pennsylvanians. As we have shown before, Pennsylvania’s state and local taxes are upside-down, with the fourth most regressive tax system of any state. The top 1% of Pennsylvania households, with an averagea income of $1.9 million, pay 6% of their income in state and local taxes, while families in the middle of the income distribution, with incomes between $47,800 and $81,899, pay 11.4% of their income. Meanwhile, families in the bottom 20% of the income distribution, with incomes below $22,100, pay 15.1% of their income in state and local taxes, the highest rate for that group in any state in the country.
Figure 1
Source: Carl Davis, et. al., Who Pays? A Distributional Analysis of the Tax Systems in All 50 States, 7th Edition, Institute on Tax and Economic Policy, January 2024, https://sfo2.digitaloceanspaces.com/itep/ITEP-Who-Pays-7th-edition.pdf.
Because of our flat tax, a half-point reduction of the PIT would reduce taxes for the top 1% of taxpayers by $5,435 per year. It would reduce taxes for the middle 20% of families by only $181 per year. And because of the tax forgiveness program, it would most likely not reduce taxes for people in the bottom 20% by more than $20 per year.
Second, for the reasons mentioned above, tax reduction should be limited.
The Republican tax plan to cut the personal income tax rate by half a point and eliminate the Gross Receipts Tax on electricity reduces state revenues by $2.711 in fiscal year 2025–26. We believe this should be upper limit for any combination of new spending and tax reductions in that year. And, since carrying out the seven-year education funding plan would itself cost $2 billion per year by the second year of the plan (2025–26), any tax reduction should be limited to about $700 million per year.
Some Republicans have suggested that cutting taxes does not harm the long-term fiscal prospects of the state. This is untrue. The impact of a recurring reduction in taxes on the state’s fiscal condition is no different than a recurring increase in spending. A reduction in revenues and an increase in expenditures of the same magnitude reduce a budget surplus or increase a budget deficit to the same extent.
Comparing the Impact of Tax Cuts and New Spending (a little wonky!)
It is true that a tax cut can have a positive, short-term impact on economic growth because households would have more money to spend and thus would consume more. But an increase in education spending of the same magnitude would also lead directly to greater consumption. And since some portion of a tax cut for wealthy families is saved not spent, additional state spending will lead to more consumption than a tax cut for the wealthy of the same magnitude.
There is also some long-term benefit from cutting personal income taxes as it may lead some people or businesses to move into the state. But the effect of a small change in income tax rates is likely to be minimal. A large body of evidence suggests that small differences in tax rates have little impact on where individuals or businesses locate, especially when we are considering moves across state lines. And spending more on K-12 education has been shown to increase long-term economic growth in two ways. Higher K-12 spending leads to better educational outcomes which in turn leads to higher wages. And better educated workers attract business development.
Given the current state of economic research, we think that the long-term benefits of increased spending on education are likely to be greater than that of a small reduction in the personal income tax rate. But the evidence at this point is certainly not conclusive.
One thing is fairly clear, however: the direct, long-term economic benefits of increased spending on education are likely to benefit current Pennsylvania children, whose long-term prospects are raised by securing a better education. And improvements in K–12 education might also lead businesses attracted by our better educated workforce to move into the state and they might bring newcomers as well. If reducing taxes leads to people and businesses moving into the state new Pennsylvanians, not current residents would receive the direct, long-term benefits. And people moving into the state to take new jobs are likely to be better off economically than low-income Pennsylvania kids who suffer from inadequately funded schools. (Of course, the indirect multiplier effects of both tax cuts and educational improvements would benefit existing and new Pennsylvanians.)
So, from the point of view of economic justice, there is no question that meeting our constitutional responsibility to adequately and equitably fund our education system is more desirable than a tax cut that does not fix our regressive tax system.
And similarly, a tax cut that disproportionately benefits low-income Pennsylvanians would be better than one that benefits high-income Pennsylvanians.
Our next two blog posts consider tax proposals that provide greater benefits to low-income Pennsylvanians. The first examines a state earned income tax cut. The second looks at two other ideas: an extension of the property tax and rent rebate program to those under the age of 65.
