States with fattened revenues who have cut their income tax may need to reverse course as effects from the One Big Beautiful Bill Act begin to manifest.
"The tax elements of the bill have in recent months, already started to wreak havoc on state revenue systems," said Wesley Tharpe, the senior advisor for state tax policy at the Center on Budget and Policy Priorities.
"That's due to technical interactions between federal and state tax codes known as conformity."
Conformity to the federal tax code is turning into a headache as nine states have already decoupled their tax code from at least one of provisions of OBBBA, also known as H.R. 1.
The moves are typically aimed at protecting their own revenue streams.
The District of Columbia has voted to ignore parts of OBBBA but Congress is attempting to
The U.S. Treasury has voiced its
The cost of conformity is spilling onto state and local governments trying to untangle the financial implications of the no tax on overtime rules and reductions in the corporate tax rates.
"We're seeing some states opt out of the largest business tax cuts under H.R.1," said Aidan Davis, state policy director for the Institute of Taxation and Economic Policy.
"What lawmakers are saying is that even if we can't stop Congress from enacting massive and highly unpopular tax cuts for big corporations, we don't have to pile on to that error with our own state tax cuts."
Several states including California, are also working decoupling efforts through their legislatures while tinkering with the dates of when certain provisions take effect.
"There are states where lawmakers are, quite frankly, sticking their heads in the sand, or are intent on muscling through deeply expensive and often top-heavy tax cuts that aren't in line with what the public wants to see," said Davis.
Some tax practitioners are predicting that states cutting income, sales, excise and property taxes are creating a perfect public finance storm.
"Over the past few years, a broad swath of mostly conservative controlled states has made their own costly policy choices that are now more fully coming home to roost," said Tharpe.
"From 2021 to 2025, 26 states cut either their personal or corporate income tax rates. Many states cut both, and many states cut multiple times."
OBBBA's biggest impact on state budgets lies mostly in the future as the most significant cuts to Medicaid don't kick in until October 2027 or later.
The states are also set to shoulder enforcing more stringent requirements and budget cuts to the Supplemental Nutrition Assistance Program.
"Some states could even be forced to end SNAP entirely if they prove unable or unwilling to come up with the money needed to fill the hole left by that federal cut," said Tharpe.
While the challenges to state budgets posed by OBBBA are formidable, Tharpe also sees opportunities for tax realignment.
"Solutions that are going to raise more money from wealthy households and corporations, as opposed to lower and moderate income," he said.
Rhode Island was the first state to decouple from OBBBA provisions and is taking steps to compensate for higher Medicaid costs by going after high income earners.
"Governor McKee has proposed a millionaire's tax expecting to raise $137 million annually, while Senator Murray and Representative Alzate, our legislative champions have reintroduced a top 1% proposal that will raise about $203 million annually," said Weayonnoh Nelson-Davies.
Nelson-Davies is the executive director of The Economics Progress Institute which is based in Rhode-Island.
