An Ironic Mix: Economy Up, Revenues Down

State lawmakers trying to close budget gaps may not find much to cheer about in recent reports that the economy is improving. In fact, the good economic news may even add irony to lawmakers’ budget debates, according to veteran fiscal analyst Nick Jenny.

The reason is that state tax revenues still are coming in well below estimates, despite the improving economy. This may lead some states to revise fiscal estimates down even as economic estimates are raised. In essence, state lawmakers will be preparing rainy day budgets while the sky is clearing — a politically touchy task.

“These shortfalls could easily outweigh the good news about an improving economy. At the very least, expect to see some unfortunate spice added to many state budget debates,” Jenny said in a press release announcing the Rockefeller Institute of Government’s latest State Fiscal News.

As an analyst at the Albany, NY-based Rockefeller, Jenny tracks the revenue flowing into state coffers. Here’s what he and deputy director Donald Boyd have found:

• Total tax collections from October through December declined by 2.7 percent compared to the same period the previous year.
• For states with income taxes, the December-January period was “devastating.” Of the 35 states for whom Rockefeller has complete information, the median tax payment was down 14.6 percent from the same period last year. This does not bode well for states counting on healthy income tax returns in April.
• The decline appears to be tied to high-income taxpayers being adversely affected by the stock market’s turmoil and the events of September 11th
• As a result, many state forecasters can be expected to downgrade their revenue estimates for the year.

Vermont had the biggest decline among the states, with estimated payments down 40 percent from last year, according to the Rockefeller Institute.

Sean Campbell, the state’s finance commissioner, , says that drop is indicative of Vermont’s tough fiscal times.

“We’ve lowered our expectations,” says Campbell. “Our year-to-year comparisons can be quite dramatic.”

Last spring, Vermont lawmakers passed a budget for the year based on $916.1 million in general fund revenue. To date, the state has fallen $49.5 million short of expectations and may fall further.

Campbell says tax cut provisions in the federal stimulus package and April tax refunds may cause further revenue reductions.

Arturo Perez, senior fiscal analyst at the National Conference of State Legislatures, says April is the month to watch.

“April’s personal income tax collections represent the biggest month for personal income tax collections. [Those collections] will be based primarily on earnings in 2001. And as you will recall, 2001 was not a good year for earnings. So you have a number of states that have revised their numbers downward,” says Perez.

“So even if at the beginning of April there is this robust assessment of the economy, it does not mean that states will be celebrating the good economic news as it comes down from Alan Greenspan,” he says.

Such a seeming conflict between economic and fiscal forecasts is not all that unusual, say longtime state budget watchers. Coming out of the past few recessions, there was a lag time between when economic activity increased and those gains were realized in state coffers. The lag time can last up to 18 months.

“There’s a lot of concern out in the states that as the economy begins to pickup there needs to a recognition that there tends to be a lag time between when the economy turns around and the states see a pickup in revenue,” says Scott Pattison, former budget chief for Virginia, now serving as executive director of the National Association of State Budget Officers.

“You’ve got to wait for employment to get back up to par. You’ve got to wait for capital gains to show up in people’s pockets. All of that is going to take several months and maybe more than a year,” says Pattison.

In testimony before the U.S. Senate Committee on Banking, Housing, and Urban Affairs earlier this month, Alan Greenspan said he expects the unemployment rate to tick higher.

“In line with past experience during the early stages of expansion, labor market performance was expected initially to lag as firms rely primarily on overtime and shifts from part-time to full-time work. The unemployment rate was anticipated to rise somewhat further over 2002, to the area of 6 to 6-1/4 percent,” Greenspan said.

For states, a rising unemployment rate will further strain budgets, as social welfare needs climb and tax revenues are depressed.

If this happens, many state lawmakers will be confronted by an uncomfortable reality — the end of the recession may not be the end of state fiscal problems.