Last week, the U.S. House of Representatives narrowly passed a budget resolution calling for $4.5 trillion in tax cuts and $2 trillion in spending cuts. The House plan would significantly reduce federal funding for Medicaid, food assistance, and other safety-net programs. The blueprint would also make permanent the 2017 Tax Cuts and Jobs Act (TCJA) provisions, which are otherwise due to lapse at the end of 2025.

      These proposed federal changes, together with ongoing budget and staffing reductions at the IRS, could present fiscal and operational challenges for states and their tax departments. Taxpayers should monitor federal budget developments and consider the potential downstream state tax effects.

Federal Spending Cuts Could Shift Costs and Tax Burdens to States

      The House plan proposes $2 trillion in spending cuts to programs that provide healthcare, nutrition assistance, and other aid to tens of millions of people. If the proposed cuts are enacted, states will see a significant reduction in federal support, particularly for Medicaid. The House budget resolution calls for at least $880 billion in cuts from the committee that oversees Medicaid, the largest source of federal funding for states. The cuts have the potential to shift hundreds of billions of dollars in Medicaid costs to states, forcing states to reduce benefits or use state dollars to cover the shortfall. Reductions in nutrition assistance and housing programs would place similar pressure on states. If state legislatures choose to offset federal cuts, state tax departments will be called upon to help fund these expanded responsibilities through enhanced revenue collection efforts.

States May Need to Address TCJA for a Second Time

      The enactment of TJCA in 2017 set off a policy scramble in the states, transforming what had historically been a routine exercise—updating tax conformity statutes—into a complex tax policy debate. States were forced to confront significant questions about revenue impacts, taxpayer burdens, and the overall shape of their tax codes. With the House now advancing legislation to make key TCJA provisions permanent, state tax systems may once again be poised for disruption, with conformity decisions expected to play a material role in shaping each state’s fiscal outlook.

      The TCJA contains both base-broadening and base-narrowing provisions, which would directly affect revenue projections in the many states that use federal income tax definitions as a starting point. Extending these provisions could significantly affect state tax revenues, with the size and direction of the impact depending on each state’s conformity rules. State legislatures may need to move quickly to determine whether to adopt or decouple from the extended provisions, particularly in static conformity states.

IRS Cuts Create Ripple Effects for States

      At the same time, state tax departments are set to face operational and enforcement challenges stemming from significant IRS staff and budget reductions. Recent presidential directives have accelerated layoffs, with 6,700 IRS employees already receiving termination notices and more rounds expected. State tax departments, which rely on IRS data and federal audit coordination, may be forced to navigate compliance gaps and diminished information sharing.

      Since most states use federal adjusted gross income (AGI) or taxable income as the starting point for their own tax calculations, a reduction in IRS enforcement and taxpayer service could affect state compliance efforts. A scaled-back IRS is expected to result in higher rates of noncompliance at both the federal and state levels, leaving state tax departments to bridge any enforcement gap left by a weakened IRS.

Shifting Federal Landscape May Trigger Stronger State Tax Enforcement

      The year ahead promises to be a pivotal one for state legislatures and state tax authorities. Potential federal tax and spending cuts, combined with ongoing disruptions at the IRS, could put significant revenue and tax administration pressures on states. With the possibility of reduced federal funding and changes to the income tax base, states may turn to stepped-up enforcement efforts across all tax types.

      Taxpayers and practitioners should closely monitor how these federal developments influence state tax policy and enforcement priorities. As states react to shifting fiscal conditions, the downstream effects could lead to a more aggressive posture from state tax departments, making proactive compliance and careful state-level tax planning more important than ever. Taxpayers are encouraged to work closely with their tax advisors to monitor state responses and adjust compliance strategies accordingly.