The fiscal outlook for most states remains bleak, as tax revenue growth continued to lag in the first half of fiscal year 2025. This sluggish performance is partly attributable to widespread tax rate reductions and other relief measures enacted in recent years. Compounding these challenges are recent federal policy decisions—such as cuts to federal funding, new tariffs, and reductions in federal employment—which are expected to further strain state and local budgets.

Trends in Tax Revenue

State tax revenue trends in the fourth quarter of 2024 and for the first half of fiscal year 2025 (July 2024 through December 2024) reveal a complex and variable fiscal environment. While some tax streams showed gains, broader patterns highlight ongoing fiscal challenges and regional disparities. Below are key revenue trends in the first half of fiscal year 2025 by tax type.

• Personal income taxes: In the first half of fiscal year 2025, personal income tax revenues saw solid gains, primarily fueled by a strong stock market. However, states that recently reduced income tax rates are seeing a dip in withholding tax collections. Personal income tax collections remain increasingly volatile, particularly in states that rely heavily on high-income earners and stock market performance.
• Corporate income taxes: Corporate income tax revenues showed substantial declines in the first half of fiscal year 2025 due to weakened corporate profits and recent tax policy changes in several states.
• Sales taxes: Sales tax revenues have remained weak across most states in the first half of fiscal year 2025, continuing a trend of weak performance observed over the last two years. Year-over-year growth in the median state was just 1.9 percent in nominal terms, reflecting subdued consumer spending and broader economic uncertainty.

What to Expect in the Future

States are entering a period of growing fiscal uncertainty following several years of broad-based tax cuts and one-time relief measures. Revenue growth has slowed considerably, and recent data showing a contraction in GDP adds to concerns about an economic downturn. At the same time, federal policy shifts—including proposed funding cuts, tariffs, and job reductions—threaten to further strain state and local budgets. In this challenging environment, state policymakers must prepare for tighter budgets and adopt forward-looking strategies that maintain essential services while managing long-term fiscal risks.

What We’re Focusing On

With the Tax Cuts and Jobs Act’s (TCJA’s) $10,000 state and local tax (SALT) deduction cap set to expire at the end of the year, this quarter’s report examines state pass-through entity (PTE) taxes, which many states have implemented as a workaround. These PTE regimes allow S-corporations, partnerships, and LLCs to pay state income taxes at the entity level, thereby preserving federal deductibility and providing relief to high-income taxpayers in states like California, Connecticut, New Jersey, and New York. As a result, many taxpayers have shifted their tax payments from individual estimated and final payments to PTE-level payments, significantly altering state revenue patterns. The report also examines the outlook beyond 2025, when the SALT cap is set to expire. Without the cap, the federal benefit of PTE taxes would largely disappear, prompting states to consider whether to maintain, phase out, or redesign these regimes. Proposals that increase the SALT deduction cap could reduce the incentive for high-income taxpayers to use PTE regimes, depending on the final cap amount.