The NCSL Blog

26

By Jackson Brainerd

When the coronavirus pandemic began wreaking havoc on the American economy, the U.S. Treasury extended the filing and payment deadlines for income taxes by three months, from April 15 to July 15. 

Credit: The Volker AllianceCompelling reasons existed to do so. An extension provided a moment of financial relief to a minority of taxpayers by allowing those who owed on their returns and had not yet scheduled an April 15 payment with their banks to hold onto their cash for an additional three months.

It also gave businesses and tax preparation services time to adapt to the logistical challenges stemming from the closing of physical workspaces across the country, as certain aspects of tax filing cannot be done remotely.

While states have the authority to set their own filing deadlines, convincing administrative and political reasons exist to match the federal dates. All 45 states that levy an income tax delayed their filing dates well. Forty-one mirrored the federal government exactly and chose July 15 as their new “Tax Day.”

Filing extensions are not exactly “win-win” propositions for taxpayers and state governments. The delayed deadlines caused many problems for the states.

Personal income taxes account for approximately 38% of all state tax collections, and states receive roughly a third of this revenue during the April-June quarter when taxpayers make their final payments. The deadline extension pushed all of that revenue from fiscal year 2020 (which ends June 30 in most states) into fiscal year 2021, causing budgeting difficulties beyond what states would typically have to deal with in an economic crisis and contributing to early budget cuts and the use of reserve funds.

As July 15 approaches, there have been calls for the IRS to extend the deadline for filing tax returns until Oct. 15. The National Taxpayers Union has even called for extending deadlines into 2021. To be sure, in the midst of a recession, the economic security of American taxpayers needs to be a priority, but it is important to consider what an additional extension might mean for state governments.

While many states may feel compelled to follow another federal extension, it is not a guarantee that all would do so. Absent a concurrent state extension, a federal filing extension loses much of its benefit.  The starting point for most state income tax returns is a number (usually federal adjusted gross income or federal taxable income) pulled from federal tax returns. If a state chose not to follow the IRS’s lead, most taxpayers in that state would have to go through the process of completing their federal return anyway.

The states that followed another federal extension would likely experience serious technical difficulties in tax administration. State tax agencies would be saddled with an unprecedented burden of having to prepare for the next filing season in the middle of processing this filing season’s returns, which could be highly disruptive. 

The potential for tax fraud becomes more likely with a tax extension as well;  longer delays in filing increases the opportunity for criminal activity – use of stolen identity when filing. Furthermore, some states have other programs, such as property tax refunds, that rely on the completion of an income tax return and cannot be delayed because they’re in statute. There is not a simple explanation for how these issues could be handled.

Extending the filing season could have detrimental economic effects as well. It would mean delaying pushing tens of billions of dollars in tax refunds out into the economy. Postponing tax revenues could also result in a reduction in funding for important state government projects and programs, many of which especially affect lower-income Americans (e.g., child tax credits or earned income tax credits).

Another potential consequence is that lower-income taxpayers could be forced into paying for tax preparation services. Free tax preparations services that offer help with filing both state and federal tax returns (such as Volunteer Income Tax Assistance or Tax Counseling for the Elderly) generally close after a certain date. If these clinics need to deal with filing multiple years of returns at the same time, the high-volume could leave many taxpayers looking elsewhere for assistance.

At this moment of economic crisis, state revenue systems are hardly poised to bear additional burdens. Moody’s Analytics has estimated that the current recession will cost states up to $500 billion through FY 2022. To put that number in context, the Pew Charitable Trusts has estimated that states lost $283 billion during the Great Recession.

Absent an adequate federal aid package, which seems unlikely to materialize in the very near future, economists on both sides of the aisle agree that the required cuts to state and local spending, which is around 17% of GDP, could cause an economic depression.

The fiscal challenge facing state governments is already enormous.  While the current recession has taxpayers rightfully in search of some form of relief, any solution that could create an additional disruption to state and local budgets and revenue agencies is a risk that should be carefully considered.

Jackson Brainerd is a Senior Policy Specialist with the NCSL’s Fiscal Affairs Program.

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About the NCSL Blog

This blog offers updates on the National Conference of State Legislatures' research and training, the latest on federalism and the state legislative institution, and posts about state legislators and legislative staff. The blog is edited by NCSL staff and written primarily by NCSL's experts on public policy and the state legislative institution.