YOUR COMING STATE TAX HIKE Reform will push state income taxes up and eat into savings from the federal cut. Some people's total bill -- federal, state, and local -- will rise. Investors get hit hardest.
By Ann Reilly Dowd REPORTER ASSOCIATE Lucretia Marmon

(FORTUNE Magazine) – WITH THE much ballyhooed tax bill about to pass, many people are focusing on how much they will save on federal taxes. If you are one of them, watch out: You may be about to get blindsided. Tax reform will also affect state income taxes, mostly for the worse. For most people, state tax increases will eat away only part of the savings from the federal tax cut. But for many others the state burden will grow so much that they will wind up paying more in total taxes -- federal, state, and local combined -- than they do now. That's the case in 19 states and the District of Columbia for a typical family of four with $60,000 a year in income. This is just one of the striking conclusions drawn from a FORTUNE analysis of how tax reform will affect state and local taxes. The study, the first to examine the impact of tax reform in all 50 states and the District of Columbia, was prepared for FORTUNE by Arthur Andersen & Co. The accounting firm calculated the taxes two hypothetical families of four would pay in 1985 and 1988, after the new federal law is fully effective. One family has $60,000 in annual income, the other $120,000. Arthur Andersen calculated state and local income, sales, real estate and personal property taxes. It did not consider most local income taxes, so the tax burden is understated in such places as New York City (for the effect of reform on your state and local taxes, see table on the following pages). Some other findings from the study: The state with the highest tax bite remains New York and the lowest Alaska. In New York, the $120,000 family's taxes climb from $16,330 to $17,240; in Alaska they remain unchanged at $2,240. Tax reform will really sock it to investors. The $60,000 family's state tax rate on capital gains will shoot from 5.5% to 13.8% in New York and from 2.8% to 7.5% in Montana. People will probably look more closely than ever at state and local taxes in deciding where to live, and companies will do the same in considering where to build a new office. For example, the difference between the federal, state, and local taxes that the $120,000 family pays in New York and Vermont rises by more than $2,000 a year, to $7,900. Federal tax reform only affects income taxes, but most of them will go up. That is because 34 states and the District of Columbia tie their income taxes to the federal system; their residents will lose many deductions and income adjustments on their state taxes that Congress is taking away at the federal level. In 14 of those states, taxes also climb because residents get to deduct federal income taxes on their state returns; as federal taxes decline that state deduction will shrink. Finally, residents of most states will pay higher capital gains taxes. State and local taxes will remain unchanged in the nine states that do not have income taxes and in three states whose income taxes are not linked to the federal code. And taxes will drop in four states: Rhode Island, Vermont, Nebraska, and North Dakota. Their income taxes are a percentage of federal tax liability, so lower federal taxes will mean lower state taxes. However, the true cost of state and local taxes will rise in all 51 jurisdictions for both the $60,000 and $120,000 families. The true cost is the amount of state and local taxes a family pays minus what it saves by deducting them on its federal tax return. That is the best way to measure the burden of state and local taxes because it is the amount of spendable income that taxpayers lose. This cost of state and local taxes will rise everywhere because the federal savings from deducting them will drop substantially. Sales taxes will not be deductible at all, and lower federal tax rates will reduce the value of deducting income and property taxes. On average, the cost of state and local taxes for the $60,000 family will rise $531, or 19%. The cost for the $120,000 family jumps an average of $1,305, or 25%, and goes up by $2,000 or more in the five states shown on the map. Says Stephen Corrick, a tax partner with Arthur Andersen: ''Tax reform peels back the camouflage that has disguised the real cost of state and local taxes.'' Some governors have been promising to give back the windfalls they get from higher income taxes. But since no one really knows what the states will do, FORTUNE had Arthur Andersen base its calculations on present tax laws. Both families in the study get hit hardest if they live in high-tax states that peg income taxes to the federal tax base. They fare best in low-tax states, especially those with low sales taxes. But some of the largest percentage increases in the tax burden will come in low-tax states. Even taxpayers in states without an income tax can get skinned. In Wyoming, for example, the net cost of the $60,000 family's state and local taxes rises 25%. The $120,000 family's net taxes go up 33%. But have no pity: In both cases the taxes will still be lower than everywhere else except Alaska. The most punishing tax increases fall on capital gains. The federal government currently taxes only 40% of the gain on assets held more than six months, so that the top capital gains rate is 20%. Under tax reform, the federal government will tax the entire gain at the same rate as ordinary income. The top rate will be 28% in 1988, but families with taxable incomes above $71,900 will pay a 5% surtax to eliminate the savings from personal exemptions and the 15% rate on their first dollars of taxable income. For a family of four, the surtax applies to taxable income up to $192,930. Within that range, the top rate will really be 33%. OF THE 42 STATES that tax capital gains, 31 apply their tax to the figure reported on federal returns, now 40% of the gain. Under tax reform, those states will automatically levy their tax on the full gain unless they change their laws. In other words, their capital gains taxes will rise by 150% or more. The combined federal and state taxes on capital gains for the two families in the FORTUNE study would double in more than three-quarters of the states and the District of Columbia. If the $120,000 family lives in Iowa, its capital gains rate -- net of the savings from deducting that tax on its federal return -- rises from 1.8% to 5.7%. The family's combined federal and state tax on capital gains zooms from 18.6% to 38.7%. In Delaware, the net capital gains rate for the $60,000 family goes from 2.7% to 7.7%; the combined federal and state gains tax goes from 15.9% to 35.7%. More than ever, the best states for investors are those with no tax on capital gains: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. How will the states cope with the effects of federal tax reform? The four where income taxes will fall are already working on adjustments to recoup the lost revenue. Some politicians who expect a revenue windfall say they intend to keep some or all of the money. These include Montana Governor Ted Schwinden, Mayor Marion Barry of the District of Columbia, and gubernatorial candidates in Iowa, Virginia, and Wisconsin. And experts see more takers in the wings. Says Harold A. Hovey, editor of a newsletter called State Budget and Tax News: ''Look for substantial interest in keeping the additional money in states with fiscal problems, like Alabama, Arkansas, New Mexico, Mississippi, Iowa, Louisiana, and Oklahoma.'' The governors of New York, Michigan, Ohio, California, and Minnesota all pledge to cut taxes enough to offset their windfalls. But state legislators are talking about ''reforms'' that will leave high-income families paying more than they do now and others paying less. And don't look to the statehouse for capital gains relief. Says Raymond Scheppach, executive director of the National Governors Association: ''Most states will go along with the federal government's new treatment of capital gains. It's too complicated to do otherwise.'' One thing, at least, seems certain. As Hovey puts it, ''Next year will be the hottest in state tax policy in the decade.''