August 27, 2025 • 22 mins
Congress may have passed the One Big Beautiful Bill Act (OBBBA), but state lawmakers now face big choices. Most states link their tax codes to the federal system, meaning OBBBA’s provisions—good and bad—are about to ripple across state budgets.
In this episode, we explain why federal tax changes can automatically affect your state tax bill, the costly new personal deductions with limited benefits, and the pro-growth business provisions that remove barriers to investment and jobs.
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Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Kyle Hulehan (00:00):
hello and welcome to the Deduction a Tax
Foundation podcast.
I'm your host, Kyle Houlahan,and we are back with another
episode today.
And we are joined by Jared Waza,vice President of State Projects
here at Tax Foundation.
So.
Jared, you may have heard thatthis one small piece of
legislation passed the one bigbeautiful bill.
(00:20):
I, I don't know if you knowanything about it or have heard
of it, but I think that there'ssomething going on with that.
could you maybe explain to usreal quick what's happening in
states and, and federal taxchanges, uh, right now with the
one big beautiful bill?
Jared Walczak (00:33):
Well, yeah, Kyle, I think I have heard something
about this.
Uh, I think we can certainly saythat of those three adjectives,
it is one and it is big and, uh,at least in this case, perhaps
beauty is in the eye tobeholder.
I think that, uh, for states inparticular, there are some
really good things here.
There are some things thatpeople will disagree on.
There are some things that Ithink a lot of us have some real
questions about, and thatapplies to the entire bill, but
(00:57):
it also applies morespecifically to the tax
provisions that at least in somecases, flow through the states.
Uh, states typically begin withsome version of the internal
revenue code for the basis oftheir own individual and
corporate income taxes.
They may be up to date on whichversion of that code they use.
They may be lagging.
On that.
(01:17):
And of course that matters here.
They may decouple from certainprovisions.
Uh, there's lots of differentfactors that go into this,
including, uh, what they use astheir starting point of income.
But the bottom line here is thatthere are provisions of the new
federal law that are going toaffect the states that at least
in some states, and in manycases.
Almost all of the states aregoing to change how they tax
(01:39):
income as well.
That was true of the Tax CustomJobs Act in 2017.
That was true of the Tax ReformAct of 1986.
Uh, anytime there's a really bigchange in the federal tax code,
uh, states are paying seriousattention.
Kyle Hulehan (01:53):
So.
I'm trying to understand that.
So Congress can pass a law, theycan have federal taxes can
change, and that means me here,you know, in New Jersey, I can
end up paying more or less on mystate taxes without state
lawmakers doing anything.
Jared Walczak (02:08):
that's absolutely right.
Now, of course, uh, states havethe authority under the US
Constitution to enact their owntax codes, but for very good
reasons.
Most states begin the way thatthey calculate individual and
corporate income taxes byconforming to the Internal
Revenue code.
They want to use itsdefinitions.
They want to take advantage ofthe case law and rulings and
(02:30):
regulatory structure.
And of course, the.
Audits and enforcementcapabilities of the federal
government when they have theirown tax codes and they're doing
their TA own tax administration,so they want to be relatively
close.
They want to be conformed to theinternal revenue code.
Some states aren't as good asthat as others.
It's a really good idea,however, to conform.
(02:50):
But that doesn't mean you'regoing to do everything the same.
Obviously states for very goodreasons, don't have the same
rates as the federal government.
That would be outlandishly high.
Uh, they often have deductionsfor things the federal
government doesn't have, or theyadd back deductions.
The federal government offers,they have their own standard
deductions and personalexemptions.
Uh, they have certainincentives.
(03:10):
They're not the same code, butthey're using the same starting
point.
And therefore, when changes tothat internal revenue code, that
federal code happen, uh, there'sat least a potential.
For many of those to flowthrough to state's tax codes as
well, and that's what'shappening here.
Kyle Hulehan (03:26):
So should states automatically import every
change or should lawmakers, youknow, should they try and have
the tax code be closer to whatWashington's doing?
What?
How do you see that?
Jared Walczak (03:36):
Generally speaking, conformity is a really
good thing.
You have individuals, andespecially businesses that are
filing taxes in many states,maybe pretty much all of them.
In some cases, they wantdefinitions to mean the same
thing from one state to theother.
If there is a determination ofhow certain income is treated,
they don't want different statesto treat that income in
different ways.
(03:56):
Uh, if they are relying on afederal court ruling.
Uh, clarifying the matter.
They really hope that thatfederal court ruling also has
the same meaning in each of thestates, and that they don't have
to figure that out separately.
And for states, it's also mucheasier if you can rely
significantly on the detailsthat people put on their federal
returns, their 10 40 or theircorporate income tax returns
(04:19):
than.
You can rely pretty heavily onthe federal audit capabilities
and the federal enforcementcapabilities.
So you want it to be close.
That doesn't mean states have toconform on everything, and in
fact they don't.
They modify it in a variety ofways.
They decouple from certainprovisions, they go their own
way.
In important and significantways, but you use the same
baseline and try to speak thesame language.
(04:41):
And when states fall back, whenthey decouple for long periods
of time, you get enormouscomplexity.
You have states like Californiathat are like a decade behind on
tax conformity and it'sincredibly challenging.
If you are filing in multiplestates, especially as a business
taxpayer to figure out whatexactly is going on in
California and how many changesyou need to make in all of the
(05:01):
determinations you made to sortof decompose it into California
tax liability.
Kyle Hulehan (05:06):
So, uh, for example, you know, if, if states
are giving up, you know,billions in revenue for a
provision like excluding tips,uh, or overtime pay or something
like that, uh, that, you know,obviously narrows the, the tax
base there are.
Are, are these good policies,sound policy?
How do you see that?
Jared Walczak (05:24):
States have enacted a lot of tax cuts in
recent years.
In fact, 28 states have cutindividual income tax rates.
15 states have cut corporateincome tax rates.
Some of them are still goingback to that well, and even
making further reductions.
So there are states that wouldlike to enact further tax
relief.
But when they do that, theygenerally want bang for their
buck.
They want to see that they'regetting economic growth out of
it, or they want to see thatthey're providing relief to
(05:47):
individuals who need it.
And I don't see these asaligning well with that.
If we look, say at the newdeduction for, uh, tipped
income.
Or for, uh, premium overtime payor for auto loan interest.
We see provisions that arecostly but very poorly designed.
Tipped income.
(06:07):
For instance, we know that mosttipped employees are lower
income.
Uh, most of them are on thebottom half of the income
distribution.
So you can see this as perhapsprogressive.
You're providing a.
For lower income filers, but ofcourse not for most of them,
right?
Like only 4% of the bottom halfof the income distribution is
people employed in a tipped wagesector.
So why are you excluding, youknow, 96% of those employees?
(06:33):
Why say that someone who earns35,000 and gets a lot of it from
tips.
Gets the deduction.
Someone who earns 35,000 in adifferent profession does not,
uh, that doesn't make a lot ofsense from an equity standpoint
and from a state standpoint.
If you're asking, does thisgenerate economic growth, does
it make our state moreattractive for job creation or
migration?
(06:53):
The answer's probably going tobe no.
So I think it's very easy tolook at this and saying, we're
losing revenue.
Not getting a lot of bang forour buck.
Maybe we wanna decouple fromthis provision.
Maybe we wanna say there's noreal benefit.
And in fact, there are somesignificant distortions we may
not want in providing adeduction for auto loan
interest.
That, by the way, skews higherincome.
A lot of the, uh, you know, autoloan interest, you know, those,
(07:16):
this car loan payments areactually middle class and upper
middle income families.
Uh, but also you're encouragingpeople to take on.
Larger car loans.
Is that something the federal,the federal government should
have done?
Is it something stategovernments want to do?
Are you getting bang for yourbuck?
And I think whether it's thestate should just keep this
money and use it to, you know,use for its ordinary budgetary
(07:38):
purposes, or if you have extraresources and you wanna return
it to the taxpayer, could we doit in a better way, a more
efficient way?
I think those are validquestions.
Most states won't bring in theseprovisions.
Um, only the states that beginwith what's called federal
taxable income.
Uh, rather than adjusted grossincome, and it's a smaller
subset of states wouldautomatically bring in these
provisions.
(07:58):
But for states like that, uh,states like Colorado, Montana,
and Iowa, and a variety ofothers, these are very active
questions.
In fact, Colorado is alreadygoing into special session to
try to address some of thesequestions.
Kyle Hulehan (08:11):
Real quick, I kind of wanna hit on something that I
think is like, uh, an, anundertone of, of what you're
talking about here is somethingabout, uh, uh, the government,
how choices are made.
We don't wanna distort howchoices are made.
Could, could you maybe justbreak that down, why that's
important for our audience?
Jared Walczak (08:27):
Generally speaking, markets provide the
best allocation of resources.
Now, markets aren't perfect.
Markets don't do everything.
There is absolutely a role forgovernment in a lot of ways, but
if we are asking how much oftheir income should people put
towards car loans, should theybuy more expensive cars or not,
that's probably not a decisionwhere you want the government
putting a thumb on the scale andsaying, we're going to subsidize
(08:49):
more expensive cars.
Why would we do that?
There's really no economicjustification for that
preference.
Not only are you pushing somepeople towards a decision they
wouldn't have made otherwise,but you're also making people
subsidize the car loans even ifthey don't own a car or have
owned a cheaper car for manyyears.
Why would we choose to do that?
The primary goal of taxes is toraise adequate revenue for
(09:13):
government.
We generally want to avoidinfluencing people's economic
choices.
You can't avoid that entirely.
You're raising revenue, you'regoing to impact economic
decision making, but we don'twant to do it unnecessarily.
We certainly don't want to do itarbitrarily or capriciously.
And it's particularly weird whensometimes it feels like with
provisions like this, we'repushing, I think, perverse
(09:35):
incentives on people.
Kyle Hulehan (09:37):
So.
Why, you know, so when we knowthat, you know, investment
incentives like expensing, youknow, they drive growth and, and
job creations, why would statesrisk not conforming to federal
provisions?
Jared Walczak (09:51):
Yeah, so you've jumped into a new topic.
That's really important becausethere are these personal
deductions that are new, um, youknow, car loan interest, uh, the
higher standard deduction forseniors, which actually runs
through the personal exemptionprovision.
That's weird, but we don't needto get into it.
Um, the, you know, the.
Yeah, tipped wages and, uh, theovertime pay.
And then there's the businessexpensing provisions.
(10:13):
And this is a separate clusterand it's really important.
This is about, uh, permanent,uh, 100% full expensing, first
year expensing for certaincapital investments, um,
machinery and equipment inparticular.
Uh, there's a temporaryadditional provision for certain
structures, mainly for factoriesto also be able to take those
costs as a deduction.
First year, uh, there's arestoration of what had been the
(10:36):
longstanding policy of theUnited States to allow that
first year expensing forresearch and development, or as
the term has actually usedresearch and experimentation,
uh, those r and d expenditures.
Uh, there's other provisionslike this.
And you use the term incentive,and I actually wanna push back a
little on that.
Uh, we, I think, often fall intousing that term if there is a
provision and we see it asbenefiting something, we call it
(10:58):
an incentive, but sometimes it'sjust getting the code, right.
Uh, we aren't in this case.
Saying We're going to putsubsidies or investments towards
r and d or for capitalinvestment.
There are provisions of the taxcode that do that.
These, however, are actuallyeliminating a distortion because
when we think about corporateincome taxation, the goal is to
(11:18):
tax the profits of the business.
It is a net income tax.
But there are a lot of ways thatit's not quite a net income tax.
So of course, immediately youdeduct the cost of compensation
of your employees.
You deduct the cost of goodssold, you deduct your ordinary
business expenses, but.
Under our tax code, you don'timmediately deduct all of your
(11:40):
capital investment.
You have to depreciate yourpurchases over many years.
And that makes sense from anaccounting standpoint, right?
Like if you buy a$10 millionpiece of equipment, you aren't
$10 million poor.
You have 10 million less in cashor in those sort of liquid
assets, but you have a$10million piece of equipment and
that counts for something, butit's not profit.
(12:00):
You know, you didn't profit, youdon't say like, I have a piece
of equipment.
I'm now profiting from this.
Uh, you profit from what comesout of it.
But that was a cost of doingbusiness.
You wouldn't want to tax that.
And in the long run, the federalgovernment and the state
governments are not trying to,but they're using.
Accounting rules to depreciatethe value of that property over
time.
So you get that deduction inincrements over many years.
(12:22):
And because of the time, valueof money, because of inflation,
essentially we're distortingchoices.
Again, we're saying investmentis worse than other things, that
you get a disadvantage when youmake capital investments.
And why again, would we do that?
Why would we create anydistortion in a field like this?
But especially if we were goingto have one, why would we
distort choices about researchand development and capital
(12:44):
investment?
So these provisions are designedto fix elements of the tax code
that have been off for a numberof years with that research and
experimentation provision, uh,we had had that since the
Eisenhower administration fromthe Eisenhower administration
until 2022.
You always had first yearresearch and development
expensing, and that was greatpolicy.
(13:05):
Every state conformed to it.
If they had a corporate incometax, the federal government did
it.
Uh, but as part of the Tax Cutsand Jobs Act, this of course was
passed through reconciliation.
They needed pay fors.
In the out years, they're tryingto balance things.
They said, we are going to startamortizing this cost, doing a
five year depreciationessentially, or a five year
amortization really in thiscase, uh, starting in 2022.
(13:26):
And everyone sort of thought,well, that won't actually
happen.
That's stupid.
Why would we let that happen?
We're just going to go back andfix it, but there's a cost to
doing that.
So they didn't do it.
And now it's been done.
It's gone back to the policythat we had from the 1950s until
the, until 2022 for 68 years,and.
Some states are looking at thisnow and saying, wow, there's a
(13:47):
cost to this.
You know, really a first yearcost, because again, you were
spreading it out over fiveyears.
Now you're pulling it all backinto one year.
That first year cost is somewhatmeaningful.
The out year costs arerelatively insignificant.
It's just that time value ofmoney.
So you need to get over a oneyear hump.
And some states are looking atit and saying, I don't know
about that.
And I think sometimes they'rethinking of this as a recurring
cost that it's mostly not, butthey're thinking by decoupling
(14:11):
and I think that's a horriblechoice.
Every single state with acorporate income tax did this
for 68 years at least, assumingthey had their corporate income
tax that entire time.
Uh, they should be going back toit.
It's the pro-growth thing to do.
It's the pro investment thing todo.
If you want economic activity inyour state, you want research
and development to happen inyour state.
You don't want to bedisincentivizing it.
(14:33):
Uh, but since you're looking atthat one year cost, and I'm
really encouraging lawmakersfind ways to get over the hump.
To to bear to absorb one year ofmore cost than you normally
have, knowing that it's not veryexpensive and it's very ordinary
and it's what you always had inthe future.
One silver lining, one thingthat makes it a little easier.
States, of course were flushwith pandemic relief and they've
(14:56):
used a lot of that, but theystill have some left in most
cases, and they're allowed touse it through the end of 2026.
That's really convenient.
You have a little extra bufferjust in this period where you
have that one year hit to getback to good policy.
I hope states use it.
I hope states don't decouplefrom this important provision.
Kyle Hulehan (15:12):
So then, you know if, if it's smarter for.
Lemme say this again, if it'ssmart oto align with, with, uh,
federal policy, you know, uh,how could states and, and what
states, are there any statesthat should, are there anything
to carefully decouple from, youknow, that might not deliver
economic results?
Jared Walczak (15:31):
I think some of those personal provisions don't,
and that's not, of course, thatwe don't care about provisions
for individual filers.
Uh, we do, but the way todeliver that relief is income
tax rate reductions, and that'swhat states have done.
Uh, 28 states have cutindividual income tax rates.
If there's another state outthere that says we haven't done
it and we should.
Yeah, go do it.
Uh, that is the way to providethat relief, not to conform to
(15:53):
some of these, uh, maybe morecurious.
And also, by the way, temporaryprovisions, like tipped income
deductions, that's not going toprovide meaningful relief to
most taxpayers.
It's not going to boost youreconomy.
It doesn't make you moreattractive for economic growth
or migration or whatever elseyou might care about.
So that's the wrong way to focuson it.
If you wanna provide relief, dothe rate reductions, but
(16:14):
structure really matters in alot of ways and for businesses.
These expensing provisions arebasically getting it right.
This is how you're supposed todo tax policy.
So I hope that states willconform to them, uh, that they
won't decouple from them.
There's an opportunity for themto align.
Now, uh, pretty much everystate, really every state
conforms automatically to theresearch and experimentation
(16:36):
piece if and when they updatetheir conformity to the post
three post reconciliation actversion of the tax code.
Some states.
Actually already do this.
They either are so far outtadate that they didn't catch this
change.
Uh, in 2022.
A few states are like that, orthey realized, Hey, this is bad
policy.
The federal government's makinga mistake.
We are going to offer itregardless.
So they don't change.
(16:57):
But for the rest of states, whenthey update their conformity or
if they have ruling conformity,just automatically they bring
this in.
I hope they update thatconformity.
I hope that if they have rollingconformity, they maintain this,
don't decouple from it.
Other provisions, like, uh, 1 68K, which is the code section for
that full expensing formachinery and equipment.
Um, this was offered for thefirst time under the Tax Custom
(17:19):
Jobs Act.
There were previous, they calledit bonus depreciation.
Used to be able to get 30% inthe first year, then 50%, and
then finally a hundred before itbegan phasing back down.
It's a hundred percent again.
Some states about 20 statesconform to some version of that.
Particularly there are 15 statesthat do exactly what the federal
(17:40):
government does.
If they offer 50%, 60%, ahundred percent, they, they do
that.
Um, there's three states thatprovide a hundred percent
regardless, and there's twostates that offer a fraction of
what the federal governmentdoes, and then the rest of the
states with corporate incometaxes don't actually provide
this first year.
If you're one of those statesthat doesn't.
It's time to do it.
This is really good policy.
It's appropriate, it's how youpromote economic investment in
(18:03):
your state and how you betteralign the tax code for growth
and get a really baddisincentive out of your
corporate income tax.
You know, states talk a lotabout economic development
incentives, and then they havethis where they're not providing
this.
This is, I think.
The first step if you reallywant economic development.
Uh, so there's an opportunityfor some of these states to
conform to the first time or toincrease that conformity.
(18:24):
If they're only doing fractionalin two states, uh, for the rest
of states.
If they are conforming to this,just please keep doing it.
This is good policy.
It's worth doing.
Uh, don't see it as a way to,you know, pay for something,
especially again, where much ofthe cost is really that first
year or so.
And then after that, um, there'sobviously some additional costs
because you are accounting forthat time value of money and
(18:45):
inflation.
You're not making businessesbear these additional
unwarranted costs anymore, butit's much, much smaller than the
first year.
Kyle Hulehan (18:52):
And now be, before we sign off, I, I just want to
say, I, I, is there anythingelse on this topic that, that
you're wanting to hit on?
Or did we miss anything here?
Any important points that youfeel like we didn't get to here?
That, that you gotta get inhere?
Jared Walczak (19:05):
There's one more thing, and it's really
technical, so I'm not going togo into the details, but I just
want to acknowledge it.
Uh, for really the first time,uh, states began significantly
taxing international income whenthe tax Cuts and Jobs Act was
enacted.
And that's because there werebig changes in how the federal
government taxed internationalincome.
They actually tax it far lessnow.
(19:25):
But the way they did it, some ofthe guardrails they put in place
flowed through to the states.
So there was something calledglobal intangible, low taxed
income taxation, and a bunch ofstates started taxing that.
It's poorly designed at thestate level.
It makes very little sense forstates to be trying to apportion
a share of the income of, uh,subsidiaries, affiliates, all of
the controlled foreigncorporations as the term has it,
(19:47):
of, uh, you know, US basedmultinationals to take a share
of that for their states.
But some states did it.
Now the system has changedagain.
It's called NCTI.
It's, uh, net CFC, testedincome.
That's not a term that we needto really delve into here, but.
Only portions of it flow back tothe states.
So it becomes this really weirdsystem where the federal
(20:08):
government is trying to taxbasically as a minimum tax.
If you paid very little taxesabroad, you pay a minimum tax.
Here, the states just taxeverything.
The minimum tax doesn't workbecause there's foreign tax
credits that apply to accountfor the, you know, foreign taxes
paid, and the federal governmentaccounts for those states don't
bring the foreign tax creditsin.
So basically the states just endup taxing all the foreign income
(20:30):
or almost all of it, regardlessof how heavily taxed it is
abroad.
That makes no sense.
There's in many cases, no claimof the states on this income.
It's.
Profit shifting.
It's literally the businesses ofcourse, do business in Europe
and Asia and elsewhere.
And why would a state be taxingthat?
And what's particularlyinteresting is, um, such
ideological diversity of states.
(20:51):
Utah does this, uh, Montana,Idaho, if you had to ask me like
10 years ago, which states wouldbe on a bandwagon of excessively
taxing international income,that has absolutely nothing to
do with them.
I'm not sure if those stateswould've come to mind.
They're very competitive inother ways, but they just never
fixed this.
They conformed to it and it wasbad as guilty.
It's worse.
(21:12):
As NCTI.
Again, really technical.
We have some things on ourwebsite that go into the
details, but if I'm a statelawmaker, I'm going to really
ask some questions now about whythis is still in my code.
Kyle Hulehan (21:24):
Yeah.
Thank you for filling us in onthat and, and for filling us in
on all of this.
This is very informative.
I, I think that internationalstuff, it, it sounds very
confusing and, and doesn't makea lot of sense to me, and I
think that's correct.
It shouldn't make a lot ofsense.
Um, and so as we sign off here.
If you have any burningquestions, you can send them our
way.
You can drop a comment onYouTube.
(21:45):
You can email us atpodcast@taxfoundation.org, or
you can slide into our dms atDeduction Pod on Twitter.
you for listening.
I.
hello and welcome to the Deduction a Tax
Foundation podcast.
I'm your host, Kyle Houlahan,and we are back with another
episode today.
And we are joined by Jared Waza,vice President of State Projects
here at Tax Foundation.
So.
Jared, you may have heard thatthis one small piece of
legislation passed the one bigbeautiful bill.
(00:20):
I, I don't know if you knowanything about it or have heard
of it, but I think that there'ssomething going on with that.
could you maybe explain to usreal quick what's happening in
states and, and federal taxchanges, uh, right now with the
one big beautiful bill?
Jared Walczak (00:33):
Well, yeah, Kyle, I think I have heard something
about this.
Uh, I think we can certainly saythat of those three adjectives,
it is one and it is big and, uh,at least in this case, perhaps
beauty is in the eye tobeholder.
I think that, uh, for states inparticular, there are some
really good things here.
There are some things thatpeople will disagree on.
There are some things that Ithink a lot of us have some real
questions about, and thatapplies to the entire bill, but
(00:57):
it also applies morespecifically to the tax
provisions that at least in somecases, flow through the states.
Uh, states typically begin withsome version of the internal
revenue code for the basis oftheir own individual and
corporate income taxes.
They may be up to date on whichversion of that code they use.
They may be lagging.
On that.
(01:17):
And of course that matters here.
They may decouple from certainprovisions.
Uh, there's lots of differentfactors that go into this,
including, uh, what they use astheir starting point of income.
But the bottom line here is thatthere are provisions of the new
federal law that are going toaffect the states that at least
in some states, and in manycases.
Almost all of the states aregoing to change how they tax
(01:39):
income as well.
That was true of the Tax CustomJobs Act in 2017.
That was true of the Tax ReformAct of 1986.
Uh, anytime there's a really bigchange in the federal tax code,
uh, states are paying seriousattention.
Kyle Hulehan (01:53):
So.
I'm trying to understand that.
So Congress can pass a law, theycan have federal taxes can
change, and that means me here,you know, in New Jersey, I can
end up paying more or less on mystate taxes without state
lawmakers doing anything.
Jared Walczak (02:08):
that's absolutely right.
Now, of course, uh, states havethe authority under the US
Constitution to enact their owntax codes, but for very good
reasons.
Most states begin the way thatthey calculate individual and
corporate income taxes byconforming to the Internal
Revenue code.
They want to use itsdefinitions.
They want to take advantage ofthe case law and rulings and
(02:30):
regulatory structure.
And of course, the.
Audits and enforcementcapabilities of the federal
government when they have theirown tax codes and they're doing
their TA own tax administration,so they want to be relatively
close.
They want to be conformed to theinternal revenue code.
Some states aren't as good asthat as others.
It's a really good idea,however, to conform.
(02:50):
But that doesn't mean you'regoing to do everything the same.
Obviously states for very goodreasons, don't have the same
rates as the federal government.
That would be outlandishly high.
Uh, they often have deductionsfor things the federal
government doesn't have, or theyadd back deductions.
The federal government offers,they have their own standard
deductions and personalexemptions.
Uh, they have certainincentives.
(03:10):
They're not the same code, butthey're using the same starting
point.
And therefore, when changes tothat internal revenue code, that
federal code happen, uh, there'sat least a potential.
For many of those to flowthrough to state's tax codes as
well, and that's what'shappening here.
Kyle Hulehan (03:26):
So should states automatically import every
change or should lawmakers, youknow, should they try and have
the tax code be closer to whatWashington's doing?
What?
How do you see that?
Jared Walczak (03:36):
Generally speaking, conformity is a really
good thing.
You have individuals, andespecially businesses that are
filing taxes in many states,maybe pretty much all of them.
In some cases, they wantdefinitions to mean the same
thing from one state to theother.
If there is a determination ofhow certain income is treated,
they don't want different statesto treat that income in
different ways.
(03:56):
Uh, if they are relying on afederal court ruling.
Uh, clarifying the matter.
They really hope that thatfederal court ruling also has
the same meaning in each of thestates, and that they don't have
to figure that out separately.
And for states, it's also mucheasier if you can rely
significantly on the detailsthat people put on their federal
returns, their 10 40 or theircorporate income tax returns
(04:19):
than.
You can rely pretty heavily onthe federal audit capabilities
and the federal enforcementcapabilities.
So you want it to be close.
That doesn't mean states have toconform on everything, and in
fact they don't.
They modify it in a variety ofways.
They decouple from certainprovisions, they go their own
way.
In important and significantways, but you use the same
baseline and try to speak thesame language.
(04:41):
And when states fall back, whenthey decouple for long periods
of time, you get enormouscomplexity.
You have states like Californiathat are like a decade behind on
tax conformity and it'sincredibly challenging.
If you are filing in multiplestates, especially as a business
taxpayer to figure out whatexactly is going on in
California and how many changesyou need to make in all of the
(05:01):
determinations you made to sortof decompose it into California
tax liability.
Kyle Hulehan (05:06):
So, uh, for example, you know, if, if states
are giving up, you know,billions in revenue for a
provision like excluding tips,uh, or overtime pay or something
like that, uh, that, you know,obviously narrows the, the tax
base there are.
Are, are these good policies,sound policy?
How do you see that?
Jared Walczak (05:24):
States have enacted a lot of tax cuts in
recent years.
In fact, 28 states have cutindividual income tax rates.
15 states have cut corporateincome tax rates.
Some of them are still goingback to that well, and even
making further reductions.
So there are states that wouldlike to enact further tax
relief.
But when they do that, theygenerally want bang for their
buck.
They want to see that they'regetting economic growth out of
it, or they want to see thatthey're providing relief to
(05:47):
individuals who need it.
And I don't see these asaligning well with that.
If we look, say at the newdeduction for, uh, tipped
income.
Or for, uh, premium overtime payor for auto loan interest.
We see provisions that arecostly but very poorly designed.
Tipped income.
(06:07):
For instance, we know that mosttipped employees are lower
income.
Uh, most of them are on thebottom half of the income
distribution.
So you can see this as perhapsprogressive.
You're providing a.
For lower income filers, but ofcourse not for most of them,
right?
Like only 4% of the bottom halfof the income distribution is
people employed in a tipped wagesector.
So why are you excluding, youknow, 96% of those employees?
(06:33):
Why say that someone who earns35,000 and gets a lot of it from
tips.
Gets the deduction.
Someone who earns 35,000 in adifferent profession does not,
uh, that doesn't make a lot ofsense from an equity standpoint
and from a state standpoint.
If you're asking, does thisgenerate economic growth, does
it make our state moreattractive for job creation or
migration?
(06:53):
The answer's probably going tobe no.
So I think it's very easy tolook at this and saying, we're
losing revenue.
Not getting a lot of bang forour buck.
Maybe we wanna decouple fromthis provision.
Maybe we wanna say there's noreal benefit.
And in fact, there are somesignificant distortions we may
not want in providing adeduction for auto loan
interest.
That, by the way, skews higherincome.
A lot of the, uh, you know, autoloan interest, you know, those,
(07:16):
this car loan payments areactually middle class and upper
middle income families.
Uh, but also you're encouragingpeople to take on.
Larger car loans.
Is that something the federal,the federal government should
have done?
Is it something stategovernments want to do?
Are you getting bang for yourbuck?
And I think whether it's thestate should just keep this
money and use it to, you know,use for its ordinary budgetary
(07:38):
purposes, or if you have extraresources and you wanna return
it to the taxpayer, could we doit in a better way, a more
efficient way?
I think those are validquestions.
Most states won't bring in theseprovisions.
Um, only the states that beginwith what's called federal
taxable income.
Uh, rather than adjusted grossincome, and it's a smaller
subset of states wouldautomatically bring in these
provisions.
(07:58):
But for states like that, uh,states like Colorado, Montana,
and Iowa, and a variety ofothers, these are very active
questions.
In fact, Colorado is alreadygoing into special session to
try to address some of thesequestions.
Kyle Hulehan (08:11):
Real quick, I kind of wanna hit on something that I
think is like, uh, an, anundertone of, of what you're
talking about here is somethingabout, uh, uh, the government,
how choices are made.
We don't wanna distort howchoices are made.
Could, could you maybe justbreak that down, why that's
important for our audience?
Jared Walczak (08:27):
Generally speaking, markets provide the
best allocation of resources.
Now, markets aren't perfect.
Markets don't do everything.
There is absolutely a role forgovernment in a lot of ways, but
if we are asking how much oftheir income should people put
towards car loans, should theybuy more expensive cars or not,
that's probably not a decisionwhere you want the government
putting a thumb on the scale andsaying, we're going to subsidize
(08:49):
more expensive cars.
Why would we do that?
There's really no economicjustification for that
preference.
Not only are you pushing somepeople towards a decision they
wouldn't have made otherwise,but you're also making people
subsidize the car loans even ifthey don't own a car or have
owned a cheaper car for manyyears.
Why would we choose to do that?
The primary goal of taxes is toraise adequate revenue for
(09:13):
government.
We generally want to avoidinfluencing people's economic
choices.
You can't avoid that entirely.
You're raising revenue, you'regoing to impact economic
decision making, but we don'twant to do it unnecessarily.
We certainly don't want to do itarbitrarily or capriciously.
And it's particularly weird whensometimes it feels like with
provisions like this, we'repushing, I think, perverse
(09:35):
incentives on people.
Kyle Hulehan (09:37):
So.
Why, you know, so when we knowthat, you know, investment
incentives like expensing, youknow, they drive growth and, and
job creations, why would statesrisk not conforming to federal
provisions?
Jared Walczak (09:51):
Yeah, so you've jumped into a new topic.
That's really important becausethere are these personal
deductions that are new, um, youknow, car loan interest, uh, the
higher standard deduction forseniors, which actually runs
through the personal exemptionprovision.
That's weird, but we don't needto get into it.
Um, the, you know, the.
Yeah, tipped wages and, uh, theovertime pay.
And then there's the businessexpensing provisions.
(10:13):
And this is a separate clusterand it's really important.
This is about, uh, permanent,uh, 100% full expensing, first
year expensing for certaincapital investments, um,
machinery and equipment inparticular.
Uh, there's a temporaryadditional provision for certain
structures, mainly for factoriesto also be able to take those
costs as a deduction.
First year, uh, there's arestoration of what had been the
(10:36):
longstanding policy of theUnited States to allow that
first year expensing forresearch and development, or as
the term has actually usedresearch and experimentation,
uh, those r and d expenditures.
Uh, there's other provisionslike this.
And you use the term incentive,and I actually wanna push back a
little on that.
Uh, we, I think, often fall intousing that term if there is a
provision and we see it asbenefiting something, we call it
(10:58):
an incentive, but sometimes it'sjust getting the code, right.
Uh, we aren't in this case.
Saying We're going to putsubsidies or investments towards
r and d or for capitalinvestment.
There are provisions of the taxcode that do that.
These, however, are actuallyeliminating a distortion because
when we think about corporateincome taxation, the goal is to
(11:18):
tax the profits of the business.
It is a net income tax.
But there are a lot of ways thatit's not quite a net income tax.
So of course, immediately youdeduct the cost of compensation
of your employees.
You deduct the cost of goodssold, you deduct your ordinary
business expenses, but.
Under our tax code, you don'timmediately deduct all of your
(11:40):
capital investment.
You have to depreciate yourpurchases over many years.
And that makes sense from anaccounting standpoint, right?
Like if you buy a$10 millionpiece of equipment, you aren't
$10 million poor.
You have 10 million less in cashor in those sort of liquid
assets, but you have a$10million piece of equipment and
that counts for something, butit's not profit.
(12:00):
You know, you didn't profit, youdon't say like, I have a piece
of equipment.
I'm now profiting from this.
Uh, you profit from what comesout of it.
But that was a cost of doingbusiness.
You wouldn't want to tax that.
And in the long run, the federalgovernment and the state
governments are not trying to,but they're using.
Accounting rules to depreciatethe value of that property over
time.
So you get that deduction inincrements over many years.
(12:22):
And because of the time, valueof money, because of inflation,
essentially we're distortingchoices.
Again, we're saying investmentis worse than other things, that
you get a disadvantage when youmake capital investments.
And why again, would we do that?
Why would we create anydistortion in a field like this?
But especially if we were goingto have one, why would we
distort choices about researchand development and capital
(12:44):
investment?
So these provisions are designedto fix elements of the tax code
that have been off for a numberof years with that research and
experimentation provision, uh,we had had that since the
Eisenhower administration fromthe Eisenhower administration
until 2022.
You always had first yearresearch and development
expensing, and that was greatpolicy.
(13:05):
Every state conformed to it.
If they had a corporate incometax, the federal government did
it.
Uh, but as part of the Tax Cutsand Jobs Act, this of course was
passed through reconciliation.
They needed pay fors.
In the out years, they're tryingto balance things.
They said, we are going to startamortizing this cost, doing a
five year depreciationessentially, or a five year
amortization really in thiscase, uh, starting in 2022.
(13:26):
And everyone sort of thought,well, that won't actually
happen.
That's stupid.
Why would we let that happen?
We're just going to go back andfix it, but there's a cost to
doing that.
So they didn't do it.
And now it's been done.
It's gone back to the policythat we had from the 1950s until
the, until 2022 for 68 years,and.
Some states are looking at thisnow and saying, wow, there's a
(13:47):
cost to this.
You know, really a first yearcost, because again, you were
spreading it out over fiveyears.
Now you're pulling it all backinto one year.
That first year cost is somewhatmeaningful.
The out year costs arerelatively insignificant.
It's just that time value ofmoney.
So you need to get over a oneyear hump.
And some states are looking atit and saying, I don't know
about that.
And I think sometimes they'rethinking of this as a recurring
cost that it's mostly not, butthey're thinking by decoupling
(14:11):
and I think that's a horriblechoice.
Every single state with acorporate income tax did this
for 68 years at least, assumingthey had their corporate income
tax that entire time.
Uh, they should be going back toit.
It's the pro-growth thing to do.
It's the pro investment thing todo.
If you want economic activity inyour state, you want research
and development to happen inyour state.
You don't want to bedisincentivizing it.
(14:33):
Uh, but since you're looking atthat one year cost, and I'm
really encouraging lawmakersfind ways to get over the hump.
To to bear to absorb one year ofmore cost than you normally
have, knowing that it's not veryexpensive and it's very ordinary
and it's what you always had inthe future.
One silver lining, one thingthat makes it a little easier.
States, of course were flushwith pandemic relief and they've
(14:56):
used a lot of that, but theystill have some left in most
cases, and they're allowed touse it through the end of 2026.
That's really convenient.
You have a little extra bufferjust in this period where you
have that one year hit to getback to good policy.
I hope states use it.
I hope states don't decouplefrom this important provision.
Kyle Hulehan (15:12):
So then, you know if, if it's smarter for.
Lemme say this again, if it'ssmart oto align with, with, uh,
federal policy, you know, uh,how could states and, and what
states, are there any statesthat should, are there anything
to carefully decouple from, youknow, that might not deliver
economic results?
Jared Walczak (15:31):
I think some of those personal provisions don't,
and that's not, of course, thatwe don't care about provisions
for individual filers.
Uh, we do, but the way todeliver that relief is income
tax rate reductions, and that'swhat states have done.
Uh, 28 states have cutindividual income tax rates.
If there's another state outthere that says we haven't done
it and we should.
Yeah, go do it.
Uh, that is the way to providethat relief, not to conform to
(15:53):
some of these, uh, maybe morecurious.
And also, by the way, temporaryprovisions, like tipped income
deductions, that's not going toprovide meaningful relief to
most taxpayers.
It's not going to boost youreconomy.
It doesn't make you moreattractive for economic growth
or migration or whatever elseyou might care about.
So that's the wrong way to focuson it.
If you wanna provide relief, dothe rate reductions, but
(16:14):
structure really matters in alot of ways and for businesses.
These expensing provisions arebasically getting it right.
This is how you're supposed todo tax policy.
So I hope that states willconform to them, uh, that they
won't decouple from them.
There's an opportunity for themto align.
Now, uh, pretty much everystate, really every state
conforms automatically to theresearch and experimentation
(16:36):
piece if and when they updatetheir conformity to the post
three post reconciliation actversion of the tax code.
Some states.
Actually already do this.
They either are so far outtadate that they didn't catch this
change.
Uh, in 2022.
A few states are like that, orthey realized, Hey, this is bad
policy.
The federal government's makinga mistake.
We are going to offer itregardless.
So they don't change.
(16:57):
But for the rest of states, whenthey update their conformity or
if they have ruling conformity,just automatically they bring
this in.
I hope they update thatconformity.
I hope that if they have rollingconformity, they maintain this,
don't decouple from it.
Other provisions, like, uh, 1 68K, which is the code section for
that full expensing formachinery and equipment.
Um, this was offered for thefirst time under the Tax Custom
(17:19):
Jobs Act.
There were previous, they calledit bonus depreciation.
Used to be able to get 30% inthe first year, then 50%, and
then finally a hundred before itbegan phasing back down.
It's a hundred percent again.
Some states about 20 statesconform to some version of that.
Particularly there are 15 statesthat do exactly what the federal
(17:40):
government does.
If they offer 50%, 60%, ahundred percent, they, they do
that.
Um, there's three states thatprovide a hundred percent
regardless, and there's twostates that offer a fraction of
what the federal governmentdoes, and then the rest of the
states with corporate incometaxes don't actually provide
this first year.
If you're one of those statesthat doesn't.
It's time to do it.
This is really good policy.
It's appropriate, it's how youpromote economic investment in
(18:03):
your state and how you betteralign the tax code for growth
and get a really baddisincentive out of your
corporate income tax.
You know, states talk a lotabout economic development
incentives, and then they havethis where they're not providing
this.
This is, I think.
The first step if you reallywant economic development.
Uh, so there's an opportunityfor some of these states to
conform to the first time or toincrease that conformity.
(18:24):
If they're only doing fractionalin two states, uh, for the rest
of states.
If they are conforming to this,just please keep doing it.
This is good policy.
It's worth doing.
Uh, don't see it as a way to,you know, pay for something,
especially again, where much ofthe cost is really that first
year or so.
And then after that, um, there'sobviously some additional costs
because you are accounting forthat time value of money and
(18:45):
inflation.
You're not making businessesbear these additional
unwarranted costs anymore, butit's much, much smaller than the
first year.
Kyle Hulehan (18:52):
And now be, before we sign off, I, I just want to
say, I, I, is there anythingelse on this topic that, that
you're wanting to hit on?
Or did we miss anything here?
Any important points that youfeel like we didn't get to here?
That, that you gotta get inhere?
Jared Walczak (19:05):
There's one more thing, and it's really
technical, so I'm not going togo into the details, but I just
want to acknowledge it.
Uh, for really the first time,uh, states began significantly
taxing international income whenthe tax Cuts and Jobs Act was
enacted.
And that's because there werebig changes in how the federal
government taxed internationalincome.
They actually tax it far lessnow.
(19:25):
But the way they did it, some ofthe guardrails they put in place
flowed through to the states.
So there was something calledglobal intangible, low taxed
income taxation, and a bunch ofstates started taxing that.
It's poorly designed at thestate level.
It makes very little sense forstates to be trying to apportion
a share of the income of, uh,subsidiaries, affiliates, all of
the controlled foreigncorporations as the term has it,
(19:47):
of, uh, you know, US basedmultinationals to take a share
of that for their states.
But some states did it.
Now the system has changedagain.
It's called NCTI.
It's, uh, net CFC, testedincome.
That's not a term that we needto really delve into here, but.
Only portions of it flow back tothe states.
So it becomes this really weirdsystem where the federal
(20:08):
government is trying to taxbasically as a minimum tax.
If you paid very little taxesabroad, you pay a minimum tax.
Here, the states just taxeverything.
The minimum tax doesn't workbecause there's foreign tax
credits that apply to accountfor the, you know, foreign taxes
paid, and the federal governmentaccounts for those states don't
bring the foreign tax creditsin.
So basically the states just endup taxing all the foreign income
(20:30):
or almost all of it, regardlessof how heavily taxed it is
abroad.
That makes no sense.
There's in many cases, no claimof the states on this income.
It's.
Profit shifting.
It's literally the businesses ofcourse, do business in Europe
and Asia and elsewhere.
And why would a state be taxingthat?
And what's particularlyinteresting is, um, such
ideological diversity of states.
(20:51):
Utah does this, uh, Montana,Idaho, if you had to ask me like
10 years ago, which states wouldbe on a bandwagon of excessively
taxing international income,that has absolutely nothing to
do with them.
I'm not sure if those stateswould've come to mind.
They're very competitive inother ways, but they just never
fixed this.
They conformed to it and it wasbad as guilty.
It's worse.
(21:12):
As NCTI.
Again, really technical.
We have some things on ourwebsite that go into the
details, but if I'm a statelawmaker, I'm going to really
ask some questions now about whythis is still in my code.
Kyle Hulehan (21:24):
Yeah.
Thank you for filling us in onthat and, and for filling us in
on all of this.
This is very informative.
I, I think that internationalstuff, it, it sounds very
confusing and, and doesn't makea lot of sense to me, and I
think that's correct.
It shouldn't make a lot ofsense.
Um, and so as we sign off here.
If you have any burningquestions, you can send them our
way.
You can drop a comment onYouTube.
(21:45):
You can email us atpodcast@taxfoundation.org, or
you can slide into our dms atDeduction Pod on Twitter.
you for listening.
I.
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