American states face a revenue crisis

POLITICIANS love to talk about spending. To simplify, Democrats win leftist votes by calling it investment and promising more of it. Republicans secure conservative votes by calling it waste and pledging to make cuts. Talking candidly about how to collect the revenues that fund government is more ticklish, especially when the pain is likely to be broadly shared.

This may help to explain why a surprising number of American states are facing a revenue crisis, even as the broader economy enters its ninth year of recovery. With unemployment at a 17-year low and stockmarkets near all-time highs, one might expect state coffers to be overflowing. Yet many states find themselves struggling to collect enough revenue to balance their budgets—as most are legally obliged to do. According to the National Association of State Budget Officers, 27 states saw their revenues fall below expectations last year. While states have been grappling with rising health-care and pension-fund costs for decades, many recent woes can be blamed on sluggish revenue growth. If things do not pick up soon, states will be unprepared when a new recession strikes.

State fiscal policy is driven largely by the booms and busts of the business cycle. In economic downturns, tax revenues fall and states are forced to tighten their belts by slashing spending and raising taxes. In recoveries, revenues rise and states reopen the spigot. Historically, state officials struggled to moderate such fluctuations. Stockpiling tax dollars during good times was considered indecent. Lawmakers who refused to cut taxes when state coffers were flush risked taxpayer revolts. Fortunately, in the 1980s and 1990s most states set up budget stabilisation funds where reserves could be stashed during fat years. Today such “rainy day” funds hold some $70bn.

States are now better equipped to weather economic storms, but other challenges have emerged. State tax systems were originally designed to collect sales taxes on goods like cars, furniture and clothing. As services have grown as a share of the economy, such levies have fallen on an ever-smaller share of purchases. Low inflation has also weighed on sales taxes in recent years, according to Dan White, an economist at Moody’s Analytics, a consultancy. Since 2013, prices of services have increased by 2.6% per year while prices of goods, which generate most sales tax receipts, have decreased at an annual rate of 0.4%. William Glasgall of the Volcker Alliance, an advocacy group, points out that tax breaks also cost states billions in revenue every year. In California alone, such tax expenditures—which include exemptions, deductions and credits—cost over $60bn in annual revenue.

States nationwide have been raiding rainy-day funds and using other gimmicks to balance budgets. Such manoeuvres cannot conceal forever the larger crisis in revenue-raising. That is especially painful for Republican-run states that have spent years loudly slashing taxes, then more quietly cutting services to plug budget holes. A backlash is brewing. Teachers’ strikes have this year hit West Virginia, Oklahoma and Kentucky. Teachers in Arizona may follow suit. Even the most conservative states are having hard conversations about revenues. On March 29th, Oklahoma’s Republican governor, Mary Fallin, signed a bill that will increase teachers’ pay by raising $400m in new taxes and fees. It is the state’s first tax rise in 28 years.

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