According to officials at the Alabama Department of Revenue, the state could lose up to $154 million in fiscal 2011 if Congress does not extend the Bush tax cuts. This decline in revenue would directly impact the amount of funds available to the state’s public school system, which is largely funded by state income and sales/use tax collections.

In computing Alabama taxable income, taxpayers are allowed to deduct the amount of federal income taxes paid (commonly referred to as the “FIT deduction”). All taxpayers who pay federal income taxes benefit from the FIT deduction, including individual income taxpayers who claim the standard deduction. If Congress doesn’t renew the Bush-era tax cuts and pass the proposed alternative minimum tax (“AMT”) patch, Alabama taxpayers will face an increased federal income tax liability, and thus will receive an increased FIT deduction. An increase in the amount of taxpayers’ FIT deduction will, in turn, decrease their Alabama income tax liability.

According to the Alabama Department of Revenue’s Director of Tax Policy and Research, Curtis Stewart, “Alabamians can expect to pay approximately $3 billion more in federal income taxes per year if neither the tax cuts enacted in 2001 and 2003 are renewed, nor the annual ‘patch’ to the Alternative Minimum Tax is enacted. Because Alabamians are entitled to [the FIT deduction] when calculating their Alabama income taxes … the Alabama Education Trust Fund, into which Alabama’s income taxes are deposited, would lose approximately $106 million due to the expiration of the tax cuts plus another $48 million because the AMT will affect more and more taxpayers.”

Although no action is expected to occur prior to the November 2 elections, Congress is currently debating a variety of proposals regarding federal income taxes. In particular, President Obama has proposed preserving the tax cuts for married taxpayers filing jointly with income up to $250,000, and for single taxpayers with income up to $200,000. Stewart notes that “if the AMT patch is enacted along with the [President’s] current proposal of preserving the tax cuts for lower incomes, then Alabamians with incomes in excess of $200,000 ($250,000 for those filing jointly) will pay approximately $500 million in additional federal income taxes annually, resulting in a loss of $25 million per year of income taxes for the Education Trust Fund.”

As its name implies, the revenues from the Education Trust Fund are used for the support, maintenance, and development of public education in Alabama, as well as for other functions related to educating the state’s citizens. As mentioned, the ETF is largely funded by Alabama income and sales tax collections. In addition to the anticipated decline in income tax receipts, an increase in taxpayers’ federal income tax liability likely will reduce Alabama sales tax receipts as well. Alabama taxpayers will have less disposable income to spend on items subject to state (and local) sales tax because of the increased amounts of federal income tax employers must withhold if federal income tax rates increase.

This potential loss of revenue could be devastating to an already beleaguered Education Trust Fund. Alabama has historically been a low-tax state. Indeed, Alabama’s total state and local tax collections per person ranked lowest among all states in fiscal years 2005 through 2007, and were second lowest in 2008, according to a review of U.S. Census Bureau reports. Budget experts have already labeled the next legislative session, which doesn’t begin until March 1, 2011, as “a train wreck”. Obviously, we are closely monitoring not only the gubernatorial race but the local House and Senate races as well.