WSJ: States’ revenue troubles will only get worse

Amy Merrick’s story about the future of U.S. states’ tax revenues in yesterday’s Wall Street Journal is a must-read for anyone who’s inclined to think that state finances will turn right side up again once the economy stops plunging. She writes:

The drop in [state by state] tax revenue is set to be deeper and last longer as collections have become more sensitive to business cycles in recent years. At the same time, states face growing health-care costs and the need to replenish pension programs funded by decimated investments. And some of the stimulus funds expand programs that will require state money to sustain them after the federal largesse runs out.

And why are collections "more sensitive to business cycles"? Part of the answer lies in the 15-year run of bubble-boosted growth in financial assets, which created a sort of subsidiary bubble in capital gains tax revenues. Those inflated revenues coincided with tax cut pressures both at the federal and state levels, and helped to produce a wave of tax cuts predicated on the assumption that the capital gains gravy train could only go on and on.

Merrick continues:

State tax collections could take five years or more from when the recession began in December 2007 to recover to prerecession levels, says Donald J. Boyd, senior fellow at the Nelson A. Rockefeller Institute of Government at the State University of New York.

In addition, revenues appear to have grown more sensitive to the business cycle in the past decade, in part because capital-gains taxes have become a bigger component of tax bases, according to new research by Federal Reserve Bank of Chicago economists Leslie McGranahan and Richard Mattoon. That could prolong the effect of the downturn and, by increasing volatility, make it harder for states to plan budgets.

Minnesota is probably as good an exemplar of this trend as any state. Flush with revenues from an economy that was busy blowing a high-tech asset bubble in the 1990s, Minnesota implemented some of the steepest tax cuts in the country from 1999-2001. The first sign of trouble came in 2003, after the tech bubble collapse and 9/11 had made themselves felt but before the real estate bubble was fully inflated. The result then was a $4.3 billion deficit. But subsequently the housing bubble helped prevent fiscal crises from growing out of hand in the 2005 and 2007 budget periods. And then it all hit the fan in time for the 2009 budgeting session.

One Response to “WSJ: States’ revenue troubles will only get worse”

1. Anonymous Says:
   June 5th, 2009 at 10:10 am

   In the rush to blame tax cuts for the state’s declining financial situation, don’t forget that spending kept going up, too. Had we resisted some of the urge to splurge when the economy was roaring, the deficit would be smaller than it is today.