Swings in energy prices in recent years have contributed to greater tax revenue volatility in several states. Tax revenue fluctuations are often greatest in natural resource-dependent economies, but occur to varying degrees in all states, creating unpredictability that can confound lawmakers’ efforts to balance budgets. Over the past two decades, Alaska faced the greatest tax revenue volatility, and South Dakota the least, not counting changes caused by tax policy.
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 1998 and 2017, severance taxes on oil and minerals and corporate income taxes 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 a variety of factors, many 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. For example, seesawing energy prices led to more volatile severance tax revenue in fiscal 2017 among seven of the nine states where it was a major levy.
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 1998 and 2017, 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 5.0 for the 20 years ending in fiscal 2017, unchanged from 2016’s score. This means that total tax revenue across the states typically fluctuated 5.0 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 FY1997 to FY2017. Data were adjusted to control for the effects of tax policy changes using the National Conference of State Legislatures’ State Tax Actions reports for FY1997 to FY2017.
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. Smaller tax streams can be highly volatile. But the more minor the tax source, the less of an impact it has on a state’s overall revenue volatility.
For example, the three states with the highest overall scores—energy-rich Alaska, North Dakota, and Wyoming—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 close to 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 past decade, compared with 67.3 percent of tax revenue in Alaska, 42.3 percent in North Dakota, and 37.6 percent in Wyoming.
Similarly, in the 22 states where corporate income tax was a major source of tax revenue, it was the most volatile major source in 18. However, its average share of total tax revenue was under 10 percent in 20 of these states.
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.