States feel budget pinch amid darkening revenue projections | Analysis

A slowing economy is hitting many states’ tax collections as they craft new budgets

By: - April 11, 2023 7:19 am
A proposed reduction to Pennsylvania's corporate net income tax could be included in this year's state budget.

(Photo by Joe Raedle/Getty Images)

By Tim Henderson

After two years of record tax collections, budget writers in some states are starting to feel a revenue pinch created by a slumping stock market, banking and tech layoffs, slower consumer spending and lower energy prices.

Buoyed by higher revenues and federal aid during the pandemic, officials in many states had been promising to cut taxes and expand services next fiscal year. That could all come crashing down as high-flying revenue expectations collide with the new economic reality, which has shrunk some state projections for income and sales taxes.

“There has been a little bit of a need to rein in expectations,” said Brian Sigritz, director of state fiscal studies for the National Association of State Budget Officers. “There wouldn’t be enough money to go around for everyone’s priorities.”

California, for example, faces a $24 billion budget deficit in the coming fiscal year. Revenue is $41 billion less than had been projected, and inflation has increased the state’s costs, testing its resolve to widen safety net programs. Democratic Gov. Gavin Newsom has proposed delays and cuts in spending on items ranging from child care subsidies to climate change.

In New York state, personal income tax revenue plummeted by $9.1 billion between April 2022 and this past January, the first 10 months of the state’s fiscal year, according to a March report by Comptroller Thomas DiNapoli. In January 2022, New York projected a cumulative budget surplus of $17.3 billion over the next three years. But the new report projects a cumulative deficit of $22.2 billion in the next three years.

The decrease in New York was caused by slower economic growth but also by new tax breaks for the middle class and residents with low incomes, said Matt Ryan, a spokesperson for DiNapoli.

Last month, Maryland Comptroller Brooke Lierman called her state’s revenues a “flashing yellow light — a warning,” estimating that revenues will be $478 million less than expected for the current and upcoming fiscal years combined.

Maryland’s families with low and moderate incomes are feeling the effects of inflation, which is dampening economic growth, Lierman said in a statement. At the same time, high-income Marylanders are making less in taxable bonuses. Taxes on bonuses and investment income account for almost 20% of the state’s general fund, according to Lierman.

“The Maryland economy appears to be underperforming compared to the national economy in terms of employment and consumer spending, which explains the decreased sales and use tax and withholding income tax forecasts,” she said. “On top of that, we have an aging population larger than the national average, ongoing competition for high-wage jobs with our neighboring states, and state coffers that are very dependent on nonwage income tax from the top 1% of tax filers.”

Adam Abadir, a spokesperson for the Maryland comptroller’s office, said there was an unsustainable spike of 50% in tax payments in fiscal 2021, driven by investment and business income. Income for those high earners, concentrated in Baltimore County and the Washington, D.C., suburb of Montgomery County, slowed more than expected this year, Abadir said.

Maryland and other states vulnerable to the rising and falling fortunes of the top 1% of earners are experimenting with ways to limit their dependency on such income, said Eric Kim, head of state ratings for Fitch Ratings.

States can limit the amount built into budgets for those specific revenues, use them for one-time purposes or funnel them to rainy-day funds, Kim said. Massachusetts, for example, is studying ways to use proceeds from a new tax on incomes over $1 million.

“There are some states like Maryland that are more exposed to that, and California’s at the top of this list,” Kim said.

Another factor: In the past two years of high revenue growth, states granted a record $16 billion in tax breaks and rebates, the largest legislative reduction on record, Lucy Dadayan, a senior research associate at the Tax Policy Center, said in a March report. Some states might regret those cuts as revenues plummet back to earth, she told Stateline.

Other states also have trimmed their revenue projections in recent weeks. Last month, Washington state slashed its two-year revenue projections by $483 million, blaming lower personal income tax collections and slower residential construction.

And Colorado projected a $532.2 million drop in revenues for this fiscal year because of 2022 ballot initiatives creating more tax breaks.

Alaska might have to sacrifice proposed school funding increases and cut oil dividends to residents after the state projected a deficit of around $900 million under Republican Gov. Mike Dunleavy’s proposed budget. Dunleavy blamed the gap on lower energy prices, which means lower tax revenue for the oil-producing state.

Alaska lawmakers quashed a variety of budget additions in April because of the looming deficit, leading some Democratic state House members to walk out in protest over education funding.

But in other states, the fiscal picture remains rosy. Virginia last month said its year-to-date revenues are ahead of its forecast by $111.3 million. However, the report by Secretary of Finance Stephen Cummings also noted lower sales tax growth as Virginians spent more on nontaxable services, rather than goods they preferred to buy earlier in the COVID-19 pandemic.

GOP Gov. Glenn Youngkin said in a March release that he has no plans to slow down planned tax cuts.

“Virginians remain overtaxed, and the Commonwealth has abundant resources available to lower costs and cut taxes for families and local businesses,” Youngkin said.

But Dadayan, of the Tax Policy Center, said the economic situations of Virginia and Maryland are not much different. Virginia suffered a recent economic disappointment when Amazon paused construction of a second headquarters in Northern Virginia.

“If anything, Virginia should be worried more than Maryland,” Dadayan said. “But as is often the case, politics and partisan views shape fiscal policy choices and priorities.”

Other states are still considering more tax cuts despite dimming revenue prospects.

In February, Nebraska’s Economic Forecasting Advisory Board opted to maintain optimistic revenue projections from last year despite drops in tax revenue. The legislature is preparing to consider tax cuts proposed by GOP Gov. Jim Pillen.

Iowa lawmakers also are considering more tax cuts, after the State Revenue Estimating Conference said last year’s cuts had less of an impact on revenue than projected.

Tim Henderson is a reporter for Stateline, an initiative of the Pew Charitable Trusts, where this story first appeared

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