In a July 4 signing, President Donald Trump’s administration unveiled a $4.5 trillion tax overhaul that could slash federal taxes for millions of Americans. Yet the real battle is now at the state level, where lawmakers must decide whether to mirror the federal changes or stand apart.
Federal Cuts and State Impact
The new law introduces temporary deductions for tips, overtime wages, and interest on loans for new vehicles built in the United States. It also boosts the deduction for older adults and temporarily raises the cap on state and local tax (SALT) deductions from $10,000 to $40,000. Business-focused provisions include the ability to immediately write off 100 % of the cost of equipment and research. Forty-one states levy individual income taxes on wages and salaries, while forty-four impose corporate income taxes.
Because state tax codes are written differently, the federal breaks will automatically apply in only a handful of states. In the remaining states, the new deductions will not appear on state tax forms unless legislators choose to adopt them. Workers who receive tips or overtime will pay no federal tax on those earnings, but could still owe state taxes if their state does not conform.
Mixed Reactions from State Leaders
“States in general are approaching this skeptically,” said Carl Davis, research director at the nonprofit Institute on Taxation and Economic Policy. Treasury Secretary Scott Bessent urged states to “immediately conform,” accusing some Democratic-led states of “political obstructionism.” Bessent also implied that many Republican-led states had not yet decided whether to adopt the cuts. “By denying their residents access to these important tax cuts, these governors and legislators are forcing hardworking Americans to shoulder higher state tax burdens, robbing them of the relief they deserve and exacerbating the financial squeeze on low- and middle-income households,” Bessent said.
Jared Walczak, vice president of state projects at the nonprofit Tax Foundation, cautioned that the tip deduction could apply to nearly 70 occupation fields under an IRS rule but would still exclude many low-wage workers. “Lawmakers need to consider whether these are worth the cost,” Walczak said.
Michigan Leads the Way
Michigan became the first state to opt into the federal tax breaks for tips and overtime wages, effective in 2026. The overtime exemption is projected to cost the state nearly $113 million, while the tips break could cost about $45 million during the current budget year, according to the state treasury department. To offset these costs, Michigan decoupled from five federal corporate tax changes that would have reduced its revenues by $540 million this year.
Republican state Rep. Ann Bollin, chair of the Michigan House Appropriations Committee, explained the trade-off. “The best path forward is to have more money in people’s pockets and have less regulation – and this kind of moved in that direction,” she said.
Arizona’s Potential Decision
Arizona could be the next state to act. Democratic Gov. Katie Hobbs has urged lawmakers to adopt the tax breaks for tips, overtime, seniors and vehicle loans, and to increase the state’s standard deduction for individual income taxpayers. Republican state House leaders said they stand ready to pass the cuts when their session begins on Jan. 12.
Corporate Tax Cuts Face Resistance
In addition to Michigan, lawmakers in Delaware, Illinois, Pennsylvania and Rhode Island have passed measures to block some or all of the corporate tax cuts from taking effect in their states. A new Illinois law decoupling from a portion of the corporate tax changes could save the state nearly $250 million, said Democratic state Sen. Elgie Sims, chair of the Senate Appropriations Committee. He said that could help ensure continued funding for schools, health care and vital services.
Illinois Gov. JB Pritzker, a vocal opponent of Trump, cited budget concerns for rejecting the corporate tax cut provision. He said states already stand to lose money because of other provisions in Trump’s big bill, such as a requirement to cover more of the costs of running the Supplemental Nutrition Assistance Program. “The decoupling is an effort to try to hold back the onslaught from the federal government to make sure that we can support programs like the one we’re announcing today,” Pritzker told reporters at a December event publicizing a grant to address homelessness in central Illinois.
Key Takeaways
- Federal tax cuts could save residents and businesses hundreds of millions, but state adoption varies.
- Michigan’s 2026 tip and overtime breaks cost $158 million, offset by a $540 million corporate revenue loss.
- Illinois, Delaware, Pennsylvania and Rhode Island have blocked corporate tax cuts, citing budget and program-funding concerns.
The debate over whether to conform to Trump’s tax agenda underscores the tension between short-term tax relief and long-term fiscal stability. As January sessions loom, states will weigh the promise of immediate savings against the potential erosion of revenue needed to fund essential services.
Closing
The federal law offers a roadmap for tax relief, but its real impact will be shaped by state legislatures. Those that choose to adopt the cuts risk higher costs for their budgets, while those that opt out preserve revenue but deny residents the federal tax benefits. The coming months will reveal how many states decide to follow Trump’s lead and how the balance between tax relief and fiscal responsibility will play out across the country.
