Stateline

States Balance Budgets With Cuts, Not Taxes

States Balance Budgets With Cuts, Not Taxes

As 2011 began, the budget situation in state capitals looked more dire than just about anybody could remember. States were entering their fourth consecutive yearof a fiscal crisis, with $82 billion worth of budget gaps to close. At the same time, budget aid from the federal stimulus program was drying up.

It's turned out to be a little less horrible than expected. That's largely because more than half of the states saw more tax revenues come in than they had anticipated, a small but significant dividend from a gradually improving economy. California discovered an additional $6 billion in tax revenues that it hadn't counted on. In New Jersey, the windfall was more than $900 million; in Michigan it was $429 million.

The extra cash helped ease the sense of emergency. But it wasn't enough to save most states from the budget reckoning they anticipated. Scott Pattison, executive director of the National Association of State Budget Officers, likens the situation states faced this year to a couple who gets a hefty tax refund but still can't afford a trip to Disney World because they have too many bills to pay.

According to Pattison's group, 20 states had virtually no money in their rainy day funds. That meant those states this year essentially had to choose between making big spending cuts or raising taxes — or some combination of those two — to balance their budgets.

By and large, they've chosen spending cuts. Fresh off historic election wins in November, Republicans swept into statehouses pledging to shrink the size of government. Some 13 governors and 1,262 state legislators — a record number of both — have signed a pledgenot to raise taxes. For many of them, the imperative to close budget gaps represented not a crisis but an opportunity to realign state government around a smaller mission.

The result is budgets that contract state government to a degree never before seen in some capitals. Florida's budget spends $1 billion less than last year and $4 billion less than 2006. New York closed its $10 billion deficit with $9.3 billion in spending reductions. Arizona did away with a $1.5 billion shortfall with $1.1 billion in net spending reductions — and no new taxes.

"Everyone is cutting," says Sujit M. CanagaRetna, a tax and budget expert at the Council of State Governments. "That's a given."

Business taxes a favorite target

Not only did Republicans generally rule out tax increases this year. Several governors also pledged to cut taxes despite the huge budget shortfalls. Business taxes were a particular target as governors argued that lower taxes would encourage businesses to hire more workers.

Some business tax cuts enacted in 2011

Arizona : Cut the corporate income tax rate from 6.9 percent to 4.9 percent

Florida : Some 14,000 businesses were removed from the corporate income tax rolls

Indiana : Corporate income tax reduced by 2 percent to 6.5 percent over four years

Kansas : Will allow "expensing," which essentially expands income tax deductions for new business equipment and software

Michigan : A $1.8 billion cut in business taxes was financed with $1.5 billion in higher income tax revenue

Missouri : Will gradually phase out Missouri's corporate franchise tax over the next five years. 

Nevada : Payroll tax rates will be eliminated for the smallest of businesses.

Source: Stateline reporting

Michigan was a key battleground on corporate taxes. Republican Governor Rick Snyder made good on a campaign promise to eliminate the much-hated "Michigan Business Tax," which companies complained was not only too costly but also convoluted and difficult to calculate. The tax will be replaced with a flat 6 percent corporate income tax. Michigan will make up the $1.8 billion in lost business tax revenues with a higher tax on personal income. Under existing Michigan law, the state income tax rate was supposed to drop to 3.9 percent by 2015. The measure Snyder signed keeps the income tax rate at its current 4.35 percent until January 1, 2013, when it will drop to 4.25 percent.

In Florida, Governor Rick Scott came into office promising to phase out corporate taxes altogether. Scott's fellow Republicans in the state legislature pushed back, however, saying the $1.7 billion annual cost was too high. They scaled the tax cut package down to one that cost the state just $30 million, by removing 14,000 businesses from the corporate tax rolls.

In Nevada, lawmakers eliminated payroll taxes for small businesses. But Republican Governor Brian Sandoval also found himself boxed in by a court ruling that blew a $656 million hole in the state budget. He went along with a Democratic plan to extend $620 million in business taxes and sales taxes that were scheduled to expire at the end of June. Conservatives are furious at Sandoval for breaking his pledge not to raise taxes.

Elsewhere, Indiana reduced its corporate income tax from 8.5 percent to 6.5 percent, a tax cut that will be phased in over four years. Missouri lawmakers decided to gradually phase out the state's corporate franchise tax over the next five years. Other corporate tax cut proposals are still pending in a few states, including New Jersey and North Carolina.

Revenue raisers 

Tax increases were not as common this year as tax cuts. But those that made it through were extraordinary.

In Illinois, where a budget crisis grew so bad that the state fell months behind on paying its bills, lawmakers passed a huge tax increase in January. The measure, enacted in the waning days of a lame-duck legislative session, was even more audacious than the proposal originally put forward by Governor Pat Quinn. The Democrat had called for an income tax increase of a single percentage point, but discussions with Wall Street analysts convinced him to seek a bigger increase. Personal income taxes rose from 3 percent to 5 percent, and corporate income taxes went up from 4.8 percent to 7 percent. Both taxes will gradually decrease again beginning in 2015.

Tax increases enacted in 2011

Connecticut : Increased sales tax from 6 percent to 6.35 percent and expanded the tax base to include services such as pet grooming, yoga, and spa services; imposed new 7 percent tax on luxury goods such as boats; raised top personal income tax bracket from 6.5 percent to 6.7 percent; raised corporate tax surcharge from 10 percent to 20 percent; increased alcohol excise tax by 20 percent and the cigarette by 40 cents a pack.

Hawaii : Repealed a state income tax deduction on high-income tax payers, and for two years will apply the state's general excise tax on activities previously exempted, most notably the loading or unloading of goods at docks or airports.

Illinois
: Increased the personal income tax rate from 3 percent to 5 percent; raised the corporate income tax rate from 4.8 percent to 7 percent. Both taxes will gradually decrease beginning in 2015.

Maryland : Raised state sales tax on alcohol from 6 percent to 9 percent.

Michigan : Paid for a $1.7 billion cut in business tax cuts with $1.5 billion in higher income tax revenue. The state income tax rate was supposed to drop to 3.9 percent by 2015; instead it will stay at its current rate of 4.35 percent until January 1, 2013, when it will drop to 4.25 percent.

Nevada : Some $620 million in business and state sales taxes that were scheduled to expire were extended for the next two years. 

Vermont
: Approved a 38-cent increase in the tax on cigarettes; imposed a new tax on medical and dental insurance claims; and increased the provider tax on nursing homes and home health agencies.

Source: Stateline reporting

Connecticut followed Illinois by passing the largest tax increase in state history. With Democrats in charge of both houses of the legislature, Governor Dannel P. Malloy was able to push through higher tax rates on personal income and retail sales, as well as the sale of alcohol and cigarettes.

Other states are still debating tax increases. Democratic Governor Mark Dayton in Minnesota and Rhode Island Governor Lincoln Chafee, an independent, both campaigned last year on raising taxes. Their proposals have yet to win approval from their respective legislatures, both of which are still working on budgets for fiscal year 2012.

Deep spending cuts 

On the spending side of the ledger, cuts this year came on top of others that states already made during the recession. According to the National Association of State Budget Officers, state general fund spending decreased 6.3 percent last year, the largest decline since NASBO began collecting data in 1979. Spending levels this year are not expected to reach their pre-recession peak. In fact, indications are that they're shrinking more.

The cuts are coming from all parts of the states' budgets, slashing programs in ways that once seemed unthinkable. This year, Michigan became the first state in more than 50 years to scale back state-level unemployment benefits. Utah cut $3 million, or more than 30 percent, of its funding for state parks. Nebraska reduced aid to local governments by $22 million a year. New York eliminated 3,700 prison beds and cut some $170 million from the judiciary budget; some courts are now closing at 4:30 pm rather than 5 pm to save money.

Social services also have been hit hard with cuts. Florida stopped funding a veteran's homeless support group, and reduced payments to social workers by 15 percent.  New Mexico will end a program that supplements federal food stamp benefits for the poor. Welfare recipients in Michigan will now face a four-year, lifetime limit on benefits; meanwhile a family of three receiving welfare in Washington State will see its monthly benefits cut from $562 to $478.

Two areas of state spending came in especially hard for cuts this year, if only because they account for so much of state budgets. Medicaid, the health insurance program for the poor, accounts for 22 percent of state spending and K-12 education accounts for 21 percent. For many states, it would have been almost impossible to close budget gaps this year without scaling back these programs significantly.

With Medicaid, the states had their hands tied. The new federal health care law prohibits states from cutting eligibility or making it harder for people to apply for coverage. So states had to find other ways to control costs. Idaho reduced the amount paid to hospitals and doctors to treat Medicaid patients, an idea that some 30 governors proposed this year. Another strategy was to move more Medicaid patients into managed care. Illinois, a state where most Medicaid patients still receive care through a traditional fee-for-service model, passed a law to move half of all enrollees into managed care by 2015. Florida, where managed care already is common, decided to expand it to all patients, including the elderly and disabled.

School funding, normally a sacrosanct budget item, has been taking billion-dollar hits in states such as New York and Washington State. Some states are cutting even deeper. Florida will spend $2.5 billion less on education than it did this year, and Texas legislators are on the cusp of cutting state aid for K-12 education by $4 billion over the next two years. The cuts will fall hard on local school districts, many of which are having to lay off large numbers of teachers to balance their own budgets.

California's conundrum

Then there is California , which stands alone in the scale of its budget problems. California already has had to erase some $100 billion worth of budget deficits since fiscal 2009. Yet the state faces a structural budget deficit that forces dramatic action each year to balance revenue with spending. When Jerry Brown became governor for the second time this year, he faced a $26.6 billion deficit — an amount that exceeds the total budget in about half of the states.

In March, Brown signed into law $11 billion in spending cuts, some of them downright breathtaking in size and scope. The welfare program Cal-Works was reduced by $1 billion; parents receiving assistance will be kicked off the rolls after four years instead of five. State-subsidized child care for 11- and 12-year-olds was eliminated. Assistance for the elderly was cut, including an adult day care center program that had been considered a national model. Aid to state universities shrunk by $1 billion. California also wants to cut $1.7 billion from its Medicaid program.

The budget drama isn't over yet. Even with the unexpected revenues California reported receiving this spring, the budget gap is not yet filled. Brown is hoping to allow voters to decide whether to extend previous tax increases on sales, income and vehicles to bring in another $9.6 billion.

Nick Johnson, vice president for state fiscal policy at the Center on Budget and Policy Priorities, a liberal think tank, believes that when all the states' budgets are in for fiscal 2012, this year may well set a record for spending reductions. "What we've seen so far in terms of cuts for 2012," he says, "is deeper than anything we've seen before." 

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