Stateline Story

State Tax Cutting Brightens Outlook For Taxpayers In 2000

WASHINGTON - Thirty-seven states enacted tax cuts totaling $8.1 billion in fiscal year 1999 revenue losses, while only eleven states raised taxes, according to a year end summary of 1998 tax and budget actions released Wednesday by the Center for the Study of the States. Eight of the eleven states that enacted tax hikes cut other taxes, resulting in only four states (Alabama, Montana, South Carolina and Wyoming) enacting net tax increases.

At the same time states rushed to cut taxes, they paused to build up large balances in budget reserve funds. As fiscal year 1998 closed, the total balance of the combined state budget reserve funds hit $36.2 billion and has increased in the months since. The aggregate balance represents 8.9 percent of all FY 1998 expenditures, the highest percent since FY 1980.

The report cites the strength of the national economy as the underlying reason for the extraordinary health in state budget balances. According to the U.S. Bureau of Economic Analysis, gross domestic product growth was 3.9% for the year and reached a surprisingly strong 6.1% in the final quarter of 1999.

"Generally speaking, most analysts both in government and outside of it have been under-predicting the growth of the economy. The 1998 tax cuts can be seen as a response to the strong growth in 1997, and are not necessarily connected to the slowdown that was being projected for 1999," said Nicholas Jenny, co-author of the Rockefeller Institute's "1998 Year End Tax and Budget Summary."

California enacted the biggest tax cuts, slicing $1.3 billion from the largest tax base in the nation. The bulk of those cuts came in the form of an increase in the dependent exemption from income taxes and a vehicle license fee cut.

Colorado legislated the largest tax cut in proportion to its general fund, returning 10.7 percent of its revenues to taxpayers in the form of a constitutionally mandated rebate. Kansas produced the largest permanent tax cuts, enacting a variety of measures that amounted to tax cuts totaling 5.7 percent of its general fund revenue.

"Certainly elected officials like to be able to bring tax cuts to the electorate, so [the 1998 election] was a factor. But, the strong economy and presence of large balances in most states were stronger factors. Nineteen ninety-seven was not an election year in most states, yet we still saw big tax cuts," Jenny said.

Personal income tax cuts were once again the most popular, with thirty states cutting income taxes in a variety of ways. Eight states increased exemptions and nineteen increased exclusions, deductions or credits. Kansas and Maryland adopted earned income tax credits, and Colorado and Ohio returned income tax revenue that exceeded constitutional limits on revenue growth.

Colorado's excess revenue amounted to $563 million this year and will be refunded by a formula based on income, but will not be reported as a personal income tax refund in an effort to avoid increasing federal tax liability of Colorado taxpayers.

Massachusetts doubled the personal exemption and reduced the tax rate on "unearned" income from 12 percent to 5.95 percent, resulting in a $637 million reduction in income tax revenue for fiscal year 1999.

The personal income tax is a popular target for several reasons, the report said. Income taxes generate large amounts of revenue, are relatively easy to modify with deductions and exemptions, and can easily direct tax relief at particular groups.

The states that did not join in the overall tax cuts also did not generally share in the overall economic boom, the report said. Overall, states increased taxes by only $654 million, a small fraction of the enacted tax cuts.

Wyoming, heavily dependent on coal and oil severance taxes, enacted a gas tax increase that resulted in a $35 million revenue boost. Hawaii, mired in a recession because of its economic dependence on Asia, increased hotel taxes.

Despite the significant tax cuts, the overall balances of the state budget surpluses and reserves reached a level equal to 8.9 percent of their total expenditures for the year. This was the seventh year in a row that reserve balances grew.

The Center's report indicates that the healthy budget balances allowed states to enact tax cuts and keep spending levels stable on services such as Medicaid.

While continuing strong economic indicators are already prompting predictions of large surpluses in many states, the report indicates storm clouds on the horizon for some. California Governor Gray Davis increased an operating deficit for FY 1999 by the Legislative Analyst's Office from $1.4 billion to $2.3 billion.

West Coasts states will continue to be affected by malaise in Asian economies, and oil producing states such as Alaska, Texas and Oklahoma continue to be hurt by soft oil prices.

The Rockefeller report indicates that 1999 may not be as good a year for tax cuts as was 1998, though cutting taxes will remain a priority. If anything, the report said, the national economy now appears stronger that it did at the time states prepared their FY 2000 budgets and so states will once again be flush with surpluses and pressure to return excess revenue.