Revenue Performance Is Rock Solid as States Climb Out of the Great Recession’s Abyss
By Savannah Gilmore and Erica MacKellar
Just 10 years ago state revenues were dismal, continually falling below estimates. Lawmakers were scrambling to plug budget gaps as best they could. Across-the-board cuts, employee furloughs and targeted program reductions were the topics of countless state budget conversations. Fast forward to today, and the state fiscal scene looks very different. Revenue performance is strong, even exceeding estimates in many states.
The ongoing economic expansion has afforded state legislatures the opportunity to balance budgets and replenish rainy day funds. Ten years ago, legislators relied on a mix of cuts, reserve funding, tax increases and other revenue-raising measures to shore up falling collections. But, since the Great Recession ended, several states have either lowered or are considering lowering their tax rates.
Still, growing uncertainty surrounds economies the world over. Equity markets have been volatile, and Brexit and international trade disputes are casting a shadow over the future of the U.S. economy. Nevertheless, the Federal Reserve has signaled that it will halt interest rate hikes, recent job reports have been positive and consumer confidence remains relatively high. This dichotomy has left economists divided over whether the country is heading for another recession anytime soon.
In the meantime, state finances are stable, and based on recent tax changes there’s no clear sign of any widespread revenue challenges. Midway through fiscal year 2019, 34 of the 48 states that responded to NCSL’s budget survey of legislative fiscal offices expected revenues to meet estimates, and the rest anticipated they would exceed forecasts. That puts states in a strong position as they start to craft their budgets for fiscal year 2020, which for most begins July 1.
D.C. Drives Decisions
There’s no question the 2017 federal tax reform law and specific U.S. Supreme Court decisions drove many of the changes legislators made to their state tax policies in 2018.
Overall, tax changes made in all 50 states and the District of Columbia last year resulted in a net revenue increase of $1.3 billion. In terms of scale, that represents 0.1 percent of total tax collections in 2017, according to NCSL’s 2018 “State Tax Actions” report, which tracks tax and revenue activity during regular and special legislative sessions, as well as measures approved by voters that affected state revenues by $1 million or more.
In addition, fee increases and decreases, revenue accelerations and decelerations, and tax-compliance initiatives provided state budgets with $867.3 million in new revenue. Combine that and the $1.3 billion tax revenue increase, and total state revenues increased by about $2.2 billion.
This aggregate data offers us a good sense of the collective revenue actions taken by states, but for deeper insight, consider digging into the specific changes made in each state. Policymakers and staff may gain more useful information from knowing the details of each state’s enacted changes and by comparing revenue estimates for similar changes.
Driving the generally optimistic fiscal outlook in the current fiscal year is revenue performance that’s been strong in major tax categories, including the two that account for the largest share of state budgets: general sales and personal income taxes.
Revenue Change and Performance
Revenue from sales and use taxes increased by $847.1 million, the largest net change of any tax category in 2018, primarily thanks to the U.S. Supreme Court ruling in the Wayfair internet sales tax case. Midway through fiscal year 2019, general sales tax collections were exceeding expectations in 17 states and on target in another 14.
Stemming from tax changes made last year, sales and use tax revenues increased the most in Louisiana, Kentucky and Illinois. Louisiana’s major increase was a result of extending the state’s temporary sales tax, though at a reduced rate. Kentucky’s and Illinois’ gains derived from sales tax collections on internet purchases.
As always, lawmakers made many changes to the personal income tax in 2018. Midway through fiscal year 2019, collections were above estimates in 20 states, on target in another 11 and lagging in just six.
Personal income tax changes resulted in the highest increase in revenues in Kansas, where lawmakers enacted a major tax package in 2017 that phased in a series of changes to deductions. Those phase-ins, combined with some rate changes, resulted in an increase of $633 million. In Oklahoma, revenues increased after the Legislature, in a second special session, capped the number of itemized deductions taxpayers may take, beginning with tax year 2018. Oregon’s personal income tax revenue increase was a result of not conforming to the 2017 federal tax reform law’s new pass-through business deduction, which reduces qualified business income for certain pass-through entities by 20 percent.
Corporate income taxes make up about 5 percent of state budgets on average and can be a notoriously volatile source of revenue. Midway through fiscal year 2019, they were performing strongly. Only three states were experiencing lower than expected returns. Twenty-three states were seeing corporate income tax revenues greater than anticipated, and another 11 were on target.
New Jersey and Oregon had the largest corporate income tax revenue increases as a result of tax changes in 2018. New Jersey lawmakers enacted a 2.5 percent surtax on allocated net income over $1 million, which will bring in an estimated $425 million in fiscal year 2019. Oregon’s estimated increase of $140 million comes from conforming to the 2017 federal tax reform law’s one-time transition tax on companies bringing foreign profits back to the U.S.
Georgia, Idaho, Iowa, Kentucky, Missouri and Vermont made changes in 2018 to reduce personal income tax rates. All of them except Vermont also reduced corporate income tax rates, as did Indiana, New Hampshire and Utah. Others are considering personal income tax rate reductions in 2019.
Innovation on the Rise
Eyes are on Massachusetts as its new payroll tax to fund paid family and medical leave begins. The tax is expected to increase revenues from $750 million to $800 million in fiscal year 2020. The tax rate of 0.63 percent will be split between the employee and the employer.
A few states altered taxes on the growing sharing economy. Arizona, Hawaii, New Jersey and Oregon applied new taxes to transient accommodations. Indiana imposed an 8 percent sales tax on ride-sharing, and New Jersey imposed a 50-cent surcharge on prearranged rides.
As in the last three years, only a few states enacted changes to tobacco taxes in 2018, and all of them saw increased revenues as a result.
Three states increased their motor fuel tax rates, which is generally earmarked for transportation projects, with South Carolina receiving the biggest revenue boost. The state increased its rate by 2 cents per gallon in fiscal year 2019, for an additional $85.1 million. Overall, state motor fuel tax changes have resulted in revenue increases since 2014.
A handful of states rely heavily on severance taxes, which are most often applied to oil and natural gas extraction. Oil prices largely rebounded in 2018, and revenues for 14 of the states with a severance tax were on target or above estimate midway through fiscal year 2019. In December, New Mexico, for example, projected a $1.1 billion budget surplus, due largely to the strong performance of its severance tax.
Even Alaska, which faced some challenging budgets in recent years because of the decline in oil prices, is seeing improvements. The state relies on petroleum taxes for nearly 90 percent of revenues, and as of November 2018, the state expected nearly $1 billion more than forecasted. While oil and natural gas prices have declined some since the start of 2019, circumstances are still much improved for most mineral-dependent states.
Reserved and Ready
Revenues aren’t the only source of lawmakers’ optimism. The average fiscal year 2018 state year-end balance was 10.3 percent, meaning many states enjoy significant reserves. (The year-end balance is the amount a state has saved in a rainy day or budget stabilization fund, plus any funds they carry forward into the next fiscal year.) A state’s year-end balance is generally considered a good indication of its overall fiscal health.
California and Texas have the country’s largest aggregate reserves. California’s reserves are projected to reach $14.5 billion by the end of fiscal year 2020, and Texas anticipates a reserve balance of $11.9 billion. As a percentage of state spending, Wyoming had the largest year-end balance, covering nearly 100 percent of its general fund appropriations for fiscal year 2019.
By replenishing those reserves, states generally are positioned better to weather the next economic downturn.
Never Without Concern
Despite the overall stability of state budgets and the optimism driven by revenue collections, some long-term budgeting pressures remain. Increasing Medicaid costs continue to place strain on state finances, with spending growing 4.8 percent from fiscal year 2018 to fiscal year 2019 and accounting for more than 20 percent of general fund budgets.
In the last few years, some states have also used one-time funds to balance their budgets. Additionally, some states, such as Alaska, North Dakota and Pennsylvania, are working to better align state expenditures with revenues. Other states, such as Connecticut and Rhode Island, are experiencing short-term budget stability but could see less revenue in the near future without policy changes.
Despite the flurry of changes that took place last year, many states haven’t responded to Wayfair, and others have yet to act on the 2017 federal tax reform law—and those actions would be in addition to any other tax changes states may want to tackle. There’s no doubt 2019 legislative sessions could result in at least as many state tax actions as last year’s did.
Some states may look to increase funding for K-12 education or address transportation and infrastructure concerns during this legislative session. Some also face instability from their pension plans. But, despite these long-term concerns, it’s clear that many states are better prepared for a potential recession. In the meantime, policymakers hope the good times keep rolling a bit longer.
—Savannah Gilmore is a policy associate and Erica MacKellar is a senior policy specialist in NCSL’s Fiscal Affairs Program.