State tax hikes could go too far

NEW YORK (CNNMoney.com) -- Some U.S. states facing steep budget gaps have resorted to tax policies that could be harmful over the long term, a non-profit research group said Monday.

In a review of 2010 changes in state tax policy, the Tax Foundation said certain states have targeted tax increases on high-income earners, smokers and out-of-state business transactions. These taxes may be politically convenient, but the foundation said that relying too heavily on such sources can lead to problems over the long run.

"Relatively high taxes on high-income individuals, smokers and out-of-state business transactions can make a state less attractive and create more volatility in an already uncertain economic climate," said Joseph Henchman, director of state projects at the Tax Foundation.

The tax increases come as states across the nation struggle to recover from the Great Recession. State tax revenues have been depleted by the weak economy and demand for social services has risen as unemployment remains high.

According the National Conference of State Legislatures, 33 states project budget gaps for fiscal year 2012, and 23 states for fiscal year 2013.

But the Tax Foundation said some states have resorted to targeted taxes and accounting "gimmicks" to paper over budget shortfalls and avoid any significant cuts in spending. This approach is irresponsible, the group says, because it assumes the economy will recover quickly.

"When the recession ends, states need to have the right policies in place that will promote economic growth and maintain revenue stability," said Henchman.

In Oregon, voters approved a measure to temporarily increase income taxes to 10.8% on income over $125,000, and 11% on income over $250,000. This so-called "millionaires' tax" could force high-income earners to leave Oregon, which will eventually hurt the state economy, the Tax Foundation said.

However, other states have eliminated or lowered taxes on top earners.

New Jersey Gov. Chris Christie vetoed a bill in June to renew the state's "millionaires' tax." In addition, Rhode Island passed a tax reform law that would, among other things, lower the top income tax rate to 5.99% from 9.9% in 2011.

Meanwhile, the review said that five states have increased cigarette taxes so far in this year. That compares with a total of 18 states in 2009.

Hawaii, New Mexico, New York, South Carolina and Utah have all recently raised state taxes on tobacco.

Washington has levied a tax on carbonated soft drinks, but New York and the District of Columbia decided against doing so, according to the review. Mississippi is looking into a tax on the syrup used to sweeten carbonated soft drinks. Colorado recently removed sugared beverages and candy from the list of groceries that were exempt from sales tax.

In addition to targeted taxes, the report said some states have raised overall sales tax rates this year.

Arizona voters approved a three-year increase on sales tax to 6.6% from 5.6%. Kansas increases sales taxes to 6.3% from 5.3%. However, Arkansas cut sales taxes on groceries to 2% from 3%.

The review also took issue with a new sales tax regulations in Colorado aimed at online retailers. According to the Tax Foundation, out-of-state retailers such as Amazon have already terminated affiliate relationships within the state and some have launched a legal battle to challenge the law.