Tax Revenue Volatility Poses Budget Challenges for Some States
Yearly swings in tax revenue can confound policymakers’ best efforts to balance state budgets. These fluctuations vary greatly across the 50 states. Over the past two decades, Alaska has faced by far the greatest volatility in total tax revenue, while South Dakota has experienced the least, not counting revenue swings caused by tax policy changes.
Revenue volatility differs across states because each relies on a unique mix of tax streams. Individual tax streams experience different fluctuations from year to year, contributing to a state’s overall revenue volatility. Between fiscal years 1996 and 2015, corporate income taxes and severance taxes on oil and minerals were consistently more volatile than other major state taxes, such as those on personal income and sales of goods and services.
Although states can raise or lower tax revenue by changing tax policies, the underlying volatility of individual tax streams is often driven by factors outside policymakers’ control. These include economic factors—such as the mix of industry, natural resources, workforce, and population growth—as well as federal budget changes and unforeseen events, such as natural disasters.
In this analysis, The Pew Charitable Trusts removes the estimated effect of state tax policy changes to calculate a volatility score for the underlying trends in each state’s overall tax revenue and major taxes—those that account for at least 5 percent of its tax revenue on average over the past decade. The scores measure the variation in year-over-year percent changes between fiscal 1996 and 2015, based on a calculation of standard deviation. A low score means that revenue levels were similar from year to year, and a high score indicates that revenue grew or declined more dramatically.
Nationwide, overall state tax revenue had a volatility score of 5.1 for the 20 years ending in fiscal 2015, up slightly from 2014’s score of 5.0. This means that total tax revenue across the states typically fluctuated 5.1 percentage points above or below its overall growth trend. Tax revenue was more volatile than the national benchmark in 30 states and less so in 20 states.
Source: Volatility scores for each state’s overall tax revenue and specific tax sources were calculated using the U.S. Census Bureau’s State Government Tax Collections historical data series from FY1995 to FY2015. Data were adjusted to control for the effects of tax policy changes using the National Conference of State Legislatures’ State Tax Actions reports for FY1995 to FY2015.
- The highest volatility occurred in Alaska (37.8 percentage points), North Dakota (12.3), Wyoming (11.6), and Vermont (11.5).
- The lowest volatility was experienced by South Dakota (2.6) and Kentucky (2.8).
- Most states had volatility scores clustered between 3.5 and 6.9 points.
- With the addition of data for fiscal 2015, volatility scores rose for 20 states, compared with scores based on the period from fiscal 1995 to 2014, though many of the increases were small enough to be obscured by rounding. The greatest increases were in Alaska and North Dakota, where low oil prices caused a drop in severance tax revenue.
- Severance tax, which is highly dependent on global energy prices, was the most volatile revenue source in seven of the nine states where it accounted for enough revenue over the past decade to be considered a major tax. Volatility scores for severance tax ranged from 15.4 in West Virginia to 46.0 in Alaska.
- Corporate income tax revenue seesawed more than any other tax source in 24 of the 30 states where it was a major tax. Volatility scores for corporate income tax ranged from 9.1 in New Hampshire to 46.8 in Delaware.
- Personal income tax, collected in 41 states, and sales tax, collected in 45 states, were relatively less volatile revenue sources. Volatility scores ranged from 3.9 in West Virginia to 13.9 in North Dakota for personal income tax, and from 2.6 in Kentucky to 14.9 in Wyoming for sales tax.
In general, two factors work in tandem to influence a state’s overall revenue volatility: how dramatically each tax stream changes from year to year and how heavily a state relies on each revenue source.
For example, the three states with the highest overall scores—energy-rich Alaska, Wyoming, and North Dakota—collected the greatest share of their tax dollars over the past 10 years from highly volatile severance taxes. Yet Texas, the largest oil producer in the nation, ranked in the middle of states for overall revenue volatility even though its severance tax revenue was more volatile than any but Alaska’s. The crucial difference is that severance tax accounted for less than 10 percent of Texas’ total tax collections over the last 10 years, compared with 67 percent of tax revenue in Alaska, 40.7 percent in Wyoming, and 38 percent in North Dakota.
Similarly, corporate income tax was the most volatile major tax source in half the states. However, its average share of total tax revenue was under 10 percent in 28 out of the 30 states that collect it.
Although volatility complicates the already difficult tasks of revenue forecasting and budgeting, it is not inherently bad. When receipts are higher than anticipated, states can improve roads and bridges, pay down debt, or build up reserves. But periods of unexpectedly high revenue may just as easily be followed by years of unanticipated low revenue that prompt spending cuts or tax increases to make ends meet.
By studying volatility, policymakers can better determine their own budgetary risk and put in place evidence-based savings strategies that harness tax growth in good years to cushion the lean years. These strategies include depositing one-time or above-average revenue into a rainy day fund and dedicating these balances to explicit, narrowly defined spending purposes. States can also reduce fiscal uncertainty by restricting spending from particularly volatile tax streams. Revenue from these streams could instead be deposited in longer-term savings accounts or sovereign wealth funds, as several natural resource-rich states do. These policies can help stabilize budgets and aid policymakers in planning for the long term.
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