Boyd 1 State Finances: Recent Trends and Outlook Indianapolis, Indiana May 6, 2002 Donald J. Boyd, Deputy Director Nelson A. Rockefeller Institute of Government Richard P. Nathan, Director

Boyd 2 States in the federal, state, local fiscal system State fiscal structure and fiscal performance State finances boomed in the 1990’s The boom was unsustainable Recent economic and fiscal news Will the boom resume? Presentation Outline

Boyd 3 States in the Federal, State, Local Fiscal System

Boyd 4 States In The Federal-State-Local Fiscal System Federal government raises the most tax revenue, followed by states then localities Federal government makes large grants to states and localities States transfer more than $300 billion to locals (1999) – 60%+ for schools Net result: “Direct” spending by locals is larger than states (but states are larger when aid payments are counted)

Boyd 5 State and Local Governments Have Been Growing Substantially

Boyd 6 Composition and Funding of State Spending

Boyd 7 “Typical” State Relies on Diversified Revenue Base

Boyd 8 There Is No Typical State – State Fiscal Structures Vary Widely Income tax: 9 states do not have broad-based income tax (AK, FL, NH, NV, SD, TN, TX, WA, WY) Sales tax: 5 states do not have broad-based sales tax (AK, DE, MT, NH, OR) K-12 Education: State share of total K-12 financing varies from 88% in HI to only 9% in NH Medicaid: A few states require local sharing in Medicaid costs (e.g., NY) Many other examples – tax limits, rebate requirements, different sales tax bases, different state-local splits of responsibility

Boyd 9 State Fiscal Structure and Fiscal Performance

Boyd 10 Income tax: –Generally grows faster than income in long run due to progressive structure –VOLATILE: may grow much faster, or much slower, than income in short run –States without income taxes, but with significant long-term spending pressure, often have fiscal difficulty (e.g., TN, NH) –States with heavy income tax reliance often are hit hard in recessions (e.g., CA, NJ, NY others) Fiscal Structure and Fiscal Performance – Income Tax

Boyd 11 Sales tax: –Broad-based tax ought to grow near rate of income in long run, if no “leakages” – BUT: (1) services generally not taxed, and economy trending toward greater service consumption, and (2) hard to collect tax on Internet, mail- order transactions –VOLATILE: may grow much faster, or even slower, than income in short run –Manufacturing states reliant on sales tax were hit hard early in the recession (OH, PA, TN) Fiscal Structure and Fiscal Performance – Sales Tax

Boyd 12 Miscellaneous other issues: –States that rely heavily on severance taxes can have sharp, irregular boom-and-bust cycles (e.g., AK, LA) –Most states don’t rely heavily on corporate taxes, but these, too, have sharp extreme revenue swings –Cigarette, motor fuel, and other excises don’t generally keep up with economy, often declining, except when states raise rates Fiscal Structure and Fiscal Performance – Other

Boyd 13 State Finances Boomed In The 1990’s

Boyd 14 Mid and late 1990’s may have been the best fiscal times ever for most states: –Income tax revenue soared due to a strong national economy and exuberant stock markets –Sales taxes were strong as consumption rose and the savings rate plummeted –Medicaid -- #2 spending item in most state budgets -- slowed from 20+% growth to low single digits –States had a welfare windfall, as federal revenue was “block granted” while caseloads shrank –Tobacco settlement In fiscal year 2000 alone, states collected about $7 billion more in income, sales, and corporate taxes than budgeted Fiscal Environment Of The 1990s

Boyd 15 States cut taxes for 7 consecutive years States, in aggregate, increased rainy day reserve funds to a 20-year high of 10.1% of expenditures States increased real per-capita spending by 28%. Medical vendor payments (essentially Medicaid) were up 79% and K- 12 education was up 31%, consuming 54% of total real per-capita spending growth. A governor’s (and legislator’s) dream How States Used The Good News

Boyd 16 The Boom Was Unsustainable

Boyd 17 Extraordinary Combination Of Forces Drove Income Tax Growth In 1990s Strong economic growth Financial markets and capital gains Bracket creep

Boyd 18 Ever-Volatile Capital Gains Grew Much Faster Than Wages

Boyd 19 Shifts Over Time: Medicaid Dominated Early 1990s, Then K-12 Was Dominant