State fiscal situations continue to rebound in the wake of the pandemic and the resulting recession. States faced steep revenue losses as consumers stayed home, some industries shuttered and many Americans lost their jobs. However, the ability of many employees to work from home helped shield states from some personal income tax losses. Consumers also proved willing to continue spending, particularly on home goods and other items that are subject to state sales taxes. The overall impact on state revenues was less than many experts feared at the start of the pandemic, but still resulted in sharply lower revenue in fiscal year 2020 than states had been projecting.
As economies opened back up, state revenues rebounded much quicker than anticipated in FY 2021. Revenue growth remained strong in FY 2022, with estimated revenues far outpacing estimates in many cases. Strong capital gains tax revenue bolstered some states, and a rebound in oil and gas prices have helped energy dependent states originally hit hard by the pandemic recover. However, states like Alaska, New Mexico and Wyoming that rely heavily on oil and gas revenues all note these revenues have been very volatile over the last few years, creating challenges and uncertainty.
On the spending side, some states have noted federal support has reduced the need for general fund spending in many areas. States including Alabama, Kansas, Nevada and Virginia have also used federal funds and surplus revenue collections for one-time projects to avoid creating a fiscal cliff if revenue growth slows and federal funds are depleted. Kansas, New Jersey and Virginia are among states that have used one-time revenues to fund retirement obligations or reduce other debt.
State revenue growth is expected to continue in FY 2023, but at a slower rate than FY 2022. Many states expect personal income tax collections to remain strong, though on average, collections are expected to decline from FY 2022 collections. This is due in part to the high level of growth seen in FY 2022, but some states have also enacted permanent or temporary personal income tax cuts, reducing collections. General sales tax collections are projected to increase on average, but growth is projected to be muted. High inflation is expected to increase state sales tax collections, but real collections may be offset by inflationary spending pressures. Many states including California, Colorado, Indiana, Montana, Texas and Washington cite inflation as a challenge for states as they consider their next annual and biennial budgets.
While overall state revenue growth is expected to be modest, state fiscal situations for FY 2023 are expected to stay strong. However, a sense exists among many states that robust revenue growth may not continue in future years, and states are making large deposits to rainy day funds to mitigate the effects of a potential economic downturn. States have largely restored withdrawals made as a result of the pandemic, and states across the country including Idaho, Iowa, Kentucky, Maine, Mississippi, Nebraska and South Carolina note healthy reserve balances.
Despite the current strength of state fiscal conditions, states face some challenges. The possibility of another recession is top of mind as legislators think about budgeting for the next few years, and states are concerned about inflationary pressures on state budgets. Like private industries, governments are also struggling to attract and retain talent, so while there is funding for many programs and initiatives, staffing shortages can create problems with implementation and delivery. Additionally, states have robust funds for capital improvements, but many are struggling with cost overruns and capacity to execute capital projects. Inflation, the war in Ukraine and other factors are also creating overall uncertainty in the U.S. economy, so while states hope the good times will continue, they are preparing for slowing growth and potential challenges ahead.
State Tax Trends in 2022 Point to Tax Relief
Lawmakers across the country were busy during 2022 legislative sessions providing tax relief to residents through both tax cuts and tax rebates. Personal income tax rates were reduced in at least 11 states. Other states gave money back to residents through rebate checks. For example, Colorado and Hawaii, bumping up against a constitutional revenue limit sent rebate checks to taxpayers. Colorado sent $750 tax refunds to individual filers ($1,500 for joint filers). Hawaii sent $300 checks. Other states giving money back to taxpayers include California, Delaware, Illinois, Massachusetts, South Carolina, and Virginia.
The number of states moving toward flat income tax rates increased significantly in 2022 legislative sessions with lawmakers in five states enacting flat tax legislation. That’s more states in one year as in the entire 20th century, when only four states adopted flat income tax rates. This year Arizona, Georgia, Iowa, and Mississippi enacted legislation to gradually reduce income tax rates provided revenue collections exceed predetermined amounts. Idaho, on the other hand, took the plunge and adopted a flat income tax rate of 5.8%.
||Current Rate (2022)
||Final Flat Tax Rate
||Flat Income Tax Rate Expected Year
*Idaho’s flat income tax of 5.8% applies retroactive to January 1st, 2022
Source note: The information used in this brief is based on preliminary survey data of state legislative fiscal offices.
Erica MacKellar is a program principal in the Fiscal Affairs Program. She covers state budget conditions and procedures, in addition to state and local fiscal relations.
Andrea Jimenez is a policy analyst in the Fiscal Affairs Program. She covers state tax issues.