Sunshine on a Cloudy Day

2/1/2015

STATE LEGISLATURES MAGAZINE | February 2015

Strong revenues brighten state fiscal forecasts, although some worry tax relief and sluggish growth could dampen the party.

By Erica Michel and Mandy Rafool

After several years of dreary state revenue growth, the future of state finances is looking a bit brighter.

But don’t pull out those Ray-Bans just yet. Although the short-term outlook is good in most states, many legislative fiscal directors remain cautious about the coming year and beyond, according to NCSL’s latest state fiscal survey. Matters are further complicated by falling oil prices’ and what effects that might bring in economic terms.

Revenues Rosy

The immediate future for state budgets, however, is looking fairly upbeat. Although low energy prices present challenges to the handful of states that rely heavily on oil production taxes, for consumers and the rest of the country, low fuel costs are good news. “We expect the drop in oil prices to be a net gain for the U.S. economy,” says Beth Ann Bovino, chief U.S. economist at Standard & Poor’s. “Low gas prices will continue to support spending,” she says.

Any increase in consumer spending will only strengthen state general fund revenues, which already are expected to be greater this fiscal year than last in a majority of states.

According to NCSL’s fiscal survey, five states anticipate revenue will surpass their original estimates, and 35 states and the District of Columbia expect revenues to meet their targets. Only six states expect revenues to come in lower than anticipated in fiscal year 2015.

Five states anticipate revenue above their estimates, while six states expect their revenues will be lower than anticipated at the close of the fiscal year.

A close look at revenues shows that the major tax categories are generally performing well. Personal income taxes, which account for the largest percentage of total state tax collections, are expected to exceed or meet revenue estimates in 28 states.

General sales taxes are also relatively strong, with 32 states meeting or exceeding their revenue estimates. With consumers paying less at the pump, many economists are now predicting an uptick in consumer spending, which could lead to an even rosier picture for state sales tax collections if gas prices stay low.

Corporate income tax collections, a notoriously volatile revenue source for states, are also on target or above estimates.

Several states also levy a tax on real estate transfers, which can be a good indicator of the health of the housing market. Nearly half the states levy these taxes and at the time of NCSL’s survey in November and December, collections were mixed. Real estate transfer taxes were exceeding expectations in four states and D.C. and meeting revenue targets in 13 states. This appears consistent with confidence in the housing market as a whole.

According to the National Association of Home Builders, the Housing Market Index was fairly stable through the last half of 2014, and showed expectations of slow, gradual growth in the housing market.

Stable Spending

In addition to a positive revenue outlook, the spending side of the ledger is also relatively stable in most states. Although about half the states currently have one or more programs running over budget, many of them note overruns are relatively minor.

Medicaid spending is exceeding budgets in 14 states, with many citing caseload increases as a primary reason. Inmate medical costs have put pressure on corrections budgets, leading to spending overruns in several states. Eight states also report K-12 education programs are over budget for a variety of reasons. Fire suppression is over budget in both Washington and Oregon after a particularly difficult wildfire season, and Washington’s natural disaster budget is in the red after a deadly mudslide last year.

Slower Than Desired

Although revenues are up, their growth rates in most states have been slow and modest. And in many states, growth rates have not returned to the levels seen before the economic downturn.

Perhaps most concerning, several officials indicated that revenue growth in their state is not keeping pace with spending. Nandana Kalupahana, with Hawaii’s House Committee on Finance, says, “Even though Hawaii ended FY 2014 with a $664 million surplus, and a surplus is again projected at the end of FY 2015, a budget deficit is projected for 2018. The state currently has a structural problem where expenditures are outpacing revenues for the next five years.”

In Arizona, long-term annual revenue growth approached 7 percent before the Great Recession. Today, the state faces an ongoing annual structural shortfall of at least $300 million to $400 million. “Given the increased size of the state compared to 20 or 30 years ago, and the change in other nationwide demographics, we may need to reset our idea of ‘normal’ revenue growth. It might be difficult to see 7 percent growth in the future,” says Richard Stavneak, director of the Joint Legislative Budget Committee in Arizona.

On the Horizon

Concerns over future revenue growth are exacerbated in many states that have implemented tax relief measures.

It’s no secret that lawmakers like to cut taxes when they can, and that is exactly what has been happening over the past few years as state revenues have slowly recovered. In the past three years, more than half the states have experienced some degree of tax reduction.

When asked to report their biggest revenue challenges for the coming year, legislative fiscal directors brought up a host of issues, many of them related to the revenue impact brought about by tax reductions.

Lawmakers in North Carolina, for example, cut taxes in 2013 by consolidating personal income tax brackets and lowering the rate. They also reduced the corporate income tax, which will continue to decrease as long as revenue targets are met. At the same time, they broadened income and sales tax bases through the elimination of several deductions and exemptions.They made some additional changes to the tax code in 2014 as well, and there has been talk of even more changes this year. The early indicators on state performance are mixed, and analysts expressed some concern over the prospect of making additional tax changes without time to fully understand the impact of the initial actions.

Another issue analysts brought up is the possibility of tax reductions at the federal level and what that could mean for revenues in states where tax systems are intrinsically tied to the federal code.

Other revenue concerns were raised by fiscal directors in states with expiring taxes. Illinois, for example, is facing a revenue reduction of more than $6 billion, starting Jan. 1, as personal and corporate income tax rates go back to their 2011 levels. Maine’s temporary tax increase on sales, meals and lodging will sunset in July. And in California, a faint blip already can be seen on the state’s fiscal-health radar screen as temporary income and sales tax increases, which generate more than $10 billion in revenue, start to phase out in 2017. 

Partly Cloudy Skies Continue

Possible storms lie ahead, as uncertainities in the world and at home weigh on the minds of state lawmakers.

Many are asking: What impact will the fall in oil prices play in the global economy? How will that affect my state? When will the international economic sluggishness pass through? Where will the next political turmoil erupt?

Will Congress and the White House continue to lock horns? Will the Federal Reserve begin to raise interest rates after years of low borrowing rates? Will the economic recovery ever reach all American families?

The questions abound, but the answers do not.

Jobs Increase, Wages Don’t

The year began with a positive outlook for job growth. At the end of 2014, nearly every sector of the economy was adding jobs. When most states began their legislative sessions, however, there were still a few storm clouds hanging around.

2014 ended with a modest growth in wages, but employee pay as a whole was up only 2.1 percent over the past year. The growth rate of wages has been mostly stagnant since the start of the economic recovery, with low-wage workers getting hit the hardest. They have so far seen less wage growth than higher-skilled employees. The clouds may be clearing, however, as economists have just begun to see wages increase at all levels.

Mandy Rafool is a program principal and Erica Michel is a research analyst in NCSL’s Fiscal Affairs Program.

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