State Finances: Recent Trends and Outlook

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State Finances RecentTrends and Outlook

• Indianapolis, Indiana
• May 6, 2002
• Donald J. Boyd, Deputy Director
• Nelson A. Rockefeller Institute of Government
• boydd_at_rockinst.org 518-443-5284
• Richard P. Nathan, Director

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Presentation Outline

• States in the federal, state, local fiscal system
• State fiscal structure and fiscal performance
• State finances boomed in the 1990s
• The boom was unsustainable
• Recent economic and fiscal news
• Will the boom resume?

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• States in theFederal, State, Local Fiscal System

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States In The Federal-State-Local Fiscal System

• Federal government raises the most tax revenue,
  followed by states then localities
• Federal government makes large grants to states
  and localities
• States transfer more than 300 billion to locals
  (1999) 60 for schools
• Net result Direct spending by locals is larger
  than states (but states are larger when aid
  payments are counted)

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State and Local Governments Have Been Growing
Substantially
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Composition and Fundingof State Spending
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Typical State Relies onDiversified Revenue Base
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There Is No Typical State State Fiscal
Structures Vary Widely

• Income tax 9 states do not have broad-based
  income tax (AK, FL, NH, NV, SD, TN, TX, WA, WY)
• Sales tax 5 states do not have broad-based sales
  tax (AK, DE, MT, NH, OR)
• K-12 Education State share of total K-12
  financing varies from 88 in HI to only 9 in NH
• Medicaid A few states require local sharing in
  Medicaid costs (e.g., NY)
• Many other examples tax limits, rebate
  requirements, different sales tax bases,
  different state-local splits of responsibility

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• State Fiscal Structure andFiscal Performance

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Fiscal Structure and Fiscal Performance Income
Tax

• Income tax
• Generally grows faster than income in long run
  due to progressive structure
• VOLATILE may grow much faster, or much slower,
  than income in short run
• States without income taxes, but with significant
  long-term spending pressure, often have fiscal
  difficulty (e.g., TN, NH)
• States with heavy income tax reliance often are
  hit hard in recessions (e.g., CA, NJ, NY others)

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Fiscal Structure and FiscalPerformance Sales
Tax

• Sales tax
• Broad-based tax ought to grow near rate of income
  in long run, if no leakages BUT (1) services
  generally not taxed, and economy trending toward
  greater service consumption, and (2) hard to
  collect tax on Internet, mail-order transactions
• VOLATILE may grow much faster, or even slower,
  than income in short run
• Manufacturing states reliant on sales tax were
  hit hard early in the recession (OH, PA, TN)

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Fiscal Structure and FiscalPerformance Other

• Miscellaneous other issues
• States that rely heavily on severance taxes can
  have sharp, irregular boom-and-bust cycles (e.g.,
  AK, LA)
• Most states dont rely heavily on corporate
  taxes, but these, too, have sharp extreme revenue
  swings
• Cigarette, motor fuel, and other excises dont
  generally keep up with economy, often declining,
  except when states raise rates

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• State FinancesBoomedIn The 1990s

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Fiscal EnvironmentOf The 1990s

• Mid and late 1990s may have been the best fiscal
  times ever for most states
• Income tax revenue soared due to a strong
  national economy and exuberant stock markets
• Sales taxes were strong as consumption rose and
  the savings rate plummeted
• Medicaid -- 2 spending item in most state
  budgets -- slowed from 20 growth to low single
  digits
• States had a welfare windfall, as federal revenue
  was block granted while caseloads shrank
• Tobacco settlement
• In fiscal year 2000 alone, states collected about
  7 billion more in income, sales, and corporate
  taxes than budgeted

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How States UsedThe Good News

• States cut taxes for 7 consecutive years
• States, in aggregate, increased rainy day reserve
  funds to a 20-year high of 10.1 of expenditures
• States increased real per-capita spending by 28.
  Medical vendor payments (essentially Medicaid)
  were up 79 and K-12 education was up 31,
  consuming 54 of total real per-capita spending
  growth.
• A governors (and legislators) dream

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• The Boom WasUnsustainable

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Extraordinary Combination Of Forces Drove Income
Tax Growth In 1990s

• Strong economic growth
• Financial markets and capital gains
• Bracket creep

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Ever-Volatile Capital GainsGrew Much Faster Than
Wages
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Shifts Over Time Medicaid Dominated Early1990s,
Then K-12 Was Dominant