Rising Revenues Explained: Are States Really Getting a Windfall?

New York lawmakers ushered in a new era of austerity this spring, curtailing their state Medicaid program and slashing funds for schools. The state’s leaders said they had little choice: New York lacked the money to meet its old commitments. But just a few months later, the state comptroller reported that tax collections were up by 25 percent from a year earlier, and that in just three months the state had collected $639 million more in taxes than it had expected when lawmakers wrote the budget. Just as the era of austerity was starting, it seemed as if New York was flush with cash. 

The truth, though, is more complicated. After years of dismal revenue reports, many states are seeing their tax collections pick up. Some are now celebrating budget surpluses. But those positive signs don’t mean that states have emerged from their fiscal crisis.

Here’s the latest on state revenue gains, what they mean — and what they don’t mean.

Are state tax collections really up? If you focus only on the short-term picture, they are up sharply. The Rockefeller Institute of Government reported last month that tax revenue across all 50 states has been increasing compared to a year earlier for five consecutive quarters. From January to March — the most recent quarter for which numbers are available — state tax revenue increased by 9.3 percent year-over-year, according to Rockefeller. That was the strongest such growth since 2006.

The strength of that growth has been a surprise to states that had become accustomed the past few years to shrinking revenue. The National Association of State Budget Officers (NASBO) said recently that 44 states are meeting or exceeding their revenue forecasts for the 2012 fiscal year. Many are in New York’s situation, with tax collections substantially exceeding forecasts.

Are tax collections up compared to when the recession began? Overall, no. Most states aren’t back to pre-recession revenue levels. In the first three months of this year, states collected less tax money than they did three years earlier.

Rockefeller predicts that will finally change when the second quarter’s numbers are in, but it will be a bit misleading. A billion dollars today isn’t worth what a billion was worth even three years ago. That’s because the country’s population is growing. It’s also because, while prices mostly have been restrained, some inflation has taken place. State revenue peaked in the second quarter of 2008. Adjusted for inflation, tax revenue was down in 47 states in the first three months of this year compared to the middle of 2008, according to data compiled by the Pew Center on the States, Stateline ‘s parent organization. North Dakota, Vermont and Oregon were the only exceptions. Nor do the rosy numbers take into account that many states raised taxes during the downturn. Without those tax increases, today’s revenue situation would look worse.

Louisiana is a particularly dramatic example of why the big picture matters, not just the impressive-sounding one-year numbers. Greg Albrecht, the chief economist of Louisiana’s Legislative Fiscal Office, says that when the books are closed on the fiscal year that ended June 30, he expects personal income tax collections to be up by 10 percent. Under normal circumstances, that would be a substantial increase — except that personal income tax revenues were down by 26 percent the year before that. “I don’t know that I’d describe what we have as a revenue surge,” Albrecht says. “Almost any performance is going to be a good performance compared to what we had in fiscal year 2010.”

What taxes are driving the increase? Revenue from all the major state taxes is increasing, but not at the same rate. The real strength comes from personal income taxes. Personal income tax collections are up largely because capital gains are up. Corporate earnings are one of the economy’s few strong points and the profits that investors have made off the stock market have translated into higher income tax payments. Sales taxes are growing more slowly, hampered by weak consumer spending. But income taxes took a bigger hit in the recession than sales taxes did, so their recovery comes from a more deeply diminished base.

What states are benefitting from the trend?  In almost all states, tax revenue finished the 2011 fiscal year up from 2010. Tax collections are up in states that were hit hard by the recession, such as Arizona, and in ones that weren’t, such as Arkansas. They’re beating expectations in wealthy Connecticut and low-income West Virginia. Still, the trend isn’t universal.

In June, for example, Washington State cut the amount of revenue it expects to bring in for the next two years. The natural disasters in Japan this spring disrupted trade and manufacturing supply chains. The simultaneous rise in gas prices didn’t help. Washington lacks a personal income tax, so its revenue system is heavily weighted toward the sales tax. “People are deleveraging,” says Arun Raha, Washington’s chief economist. “They’re paying down debt. They’re not going out and spending.” Even in fiscal year 2013, Raha expects revenue to be only at 1997 levels when adjusted for inflation and population growth.

Is the economy strong enough to sustain the revenue growth? Global financial turmoil and the recent plunge in U.S. stock market prices, combined with uncertainty over last week’s federal debt ceiling deal, are enough to give any revenue forecaster the jitters. Even if those setbacks are only temporary, most experts expect state tax collections to grow more slowly in the months ahead. “We’re not anticipating the economy is going to pick up to the point people are going to shake loose their pocketbooks,” says Richard Weiss, director of the Arkansas Department of Finance and Administration. NASBO estimates that state revenue grew by 5.9 percent in the full fiscal year that ended June 30 compared to the year before, but will only grow 2.1 percent this fiscal year.

University of Arizona economist Marshall Vest points out that his state’s personal income tax collections were up 18.5 percent in the recently concluded fiscal year, even as wages and employment — the forces that typically drive income tax growth — hardly grew at all. That’s created serious doubts about whether the quick revenue growth will last. Vest even suggests that, in part, the income tax growth may have been caused by bad economic news: People who have lost their homes no longer receive mortgage interest deductions, so they pay more in income taxes. “It’s clear now that we have a bounce off the bottom,” Vest says. “I hope that it’s not a dead-cat bounce.”

Will the extra money allow state lawmakers an easier time writing budgets next year and beyond? States can probably look forward to a year with somewhat less budget upheaval. One of the big benefits of tax collections beating forecasts is that disruptive mid-year budget cuts aren’t necessary. Mid-year cuts were nearly universal early in the downturn, but they will be a rarity this year if the revenue trends continue.

Overall, however, the fundamentals of state budgets still look gloomy. That’s partially because other levels of government are putting additional pressure on states. Some of that pressure will come from the debt ceiling agreement, which is likely to cut numerous discretionary programs that give states federal money. But it also will come from local governments. Rockefeller Institute data show that local tax revenue is now declining, as property assessments and property tax collections begin to take into account the collapse in housing values. If localities contribute less to joint state and local services such as education, that adds to the pressure. Plus, states still face the added demand for services that comes from high unemployment and economic stagnation, without the extra help the federal government had been providing through the stimulus program.

As a result, most states will find it difficult next year to restore the cuts they made throughout the downturn. Even with a little extra tax revenue, some will likely be coping with new budget gaps. “Right now, we’re in the fourth year in which states have closed massive shortfalls,” says Michael Leachman, of the Center on Budget and Policy Priorities, “and states still face new shortfalls they have to close.”