Colorado’s state budget is in jeopardy following the passage of the One Big, Beautiful Bill Act (OBBBA), a federal tax and spending measure enacted by Republicans and signed into law by President Donald Trump.
As one of only four states that utilize federal taxable income for calculating state taxes and maintain ‘rolling conformity’ with the federal tax code, Colorado is poised to experience significant financial strain.
State economists estimate that the state’s budget must address a substantial shortfall of approximately $750 million when lawmakers reconvene for a special session on August 21.
The complexity of this budget crisis stems from the relationship between state tax codes and federal income definitions.
Colorado’s tax system had been balanced until the recent passage of the OBBBA on July 4 caused an unanticipated drop in projected tax revenue, resulting in a budget imbalance.
Federal taxable income includes all income, such as capital gains, minus any investment losses and applicable deductions.
In contrast, most states rely on federal adjusted gross income, which excludes deductions and therefore leads to a higher taxable income figure for state tax calculations.
The OBBBA’s expansion of the standard deduction directly reduces individual taxpayer federal taxable income in Colorado, thereby impacting state tax revenue significantly.
Legislative staff noted that the effects of this federal act on Colorado far exceed those seen in many other states, primarily due to the starting point of state tax calculation being federal taxable income instead of adjusted gross income.
This rolling conformity with the federal tax law results in immediate adjustments to state taxes when changes occur federally, contrasting with other states that have a delay or selective adaptation approach.
The current fiscal year budget, totaling $43.9 billion, was established based on previous forecasts laid out by the legislature in April, maintaining balance until the tax law changes disrupted this equilibrium.
When President Trump’s bill became law, it catalyzed a roughly $750 million deficit due to the anticipated declines in tax revenue.
The governor’s office has warned that corporate income tax revenue could fall by as much as $950 million, while tax exemptions on overtime income could lead to an additional $290 million in revenue loss.
State estimates project an overarching impact of approximately $1.2 billion on tax revenues as a result of the OBBBA, necessitating urgent action from lawmakers to mitigate this crisis.
Proposed measures to address the shortfall will inevitably confront the constraints of the Taxpayer’s Bill of Rights (TABOR), which complicates any efforts to modify tax laws without voter approval.
State Senator Judy Amabile questioned the feasibility of shifting away from the state’s rolling conformity status, prompting a response from Mark Ferrandino, the governor’s budget chief, who acknowledged that while possible, it would require substantial restructuring of the tax system.
Ferrandino emphasized that such a change would be labor-intensive, necessitating new tax regulations and increased staffing in state revenue departments.
Despite the complexities of altering the tax framework, Governor Jared Polis has voiced his opposition to abandoning the state’s current rolling conformity.
He argues that such a change would complicate the tax filing process for Colorado residents, creating disparities between federal and state tax rules that could burden taxpayers further.
The governor also pointed out that rolling conformity allows certain lower-income taxpayers to benefit from significant exemptions, contributing to the overall efficiency of the tax system.
Economic analyses conducted in 2021 indicated that transitioning to a system based on adjusted gross income could potentially elevate tax revenues by as much as $500 million, depending on how such changes were implemented.
While many states that practice rolling conformity and federal taxable income are not currently facing similar budget woes, Colorado’s unique dynamics, including TABOR, exacerbate the issue.
State lawmakers in Colorado are restrained from modifying taxes without public approval, unlike their counterparts in North Dakota, Iowa, and Oregon, who can adjust taxes independently.
As the August special session approaches, strategies to bridge the budget gap will be paramount.
The governor’s office has floated several ideas, including reducing the state’s budget reserve by $200 million to $300 million, which would still maintain a safety net for economic downturns.
Increasing revenue could involve decisions like decoupling from federal business tax provisions and tightening regulations on corporate income shielding, among other measures.
Spending cuts are also on the table, with the governor’s office suggesting an audit of existing programs to find potential reductions, particularly outside of crucial sectors like education.
In approaching these solutions, state officials intend to weigh all options carefully, ensuring that the state can stabilize its financial standing amidst unexpected challenges.
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