William Julius Wilson
Harvard University

Federal policies that impose new costs on states and restrict state revenues have deepened the state fiscal crisis, a new report from the Center on Budget and Policy Priorities finds.  The report is the first to provide state-by-state data on the budgetary damage these policies have caused.  In all, added costs and lost revenue total $175 billion over fiscal years 2002-2005, or an average of 8.4 percent of total state general fund budgets.

As a result, states and localities have been forced to impose much larger spending cuts and tax increases than otherwise would have been necessary to balance their budgets.  This extra burden has fallen primarily on low- and middle-income families.  Not only do many such families rely on services that are being cut (such as child care and public universities), but most of the recent state tax increases have come in regressive taxes such as sales and excise taxes.

“At the same time the federal government has been passing $175 billion in costs on to states, it has enacted tax cuts that provide huge benefits to high-income families,” said Iris Lav, co-director of the Center and the report’s lead author.  “In essence, low- and middle-income families are paying for the tax cuts for affluent families in the form of higher state taxes and reduced state services.”

Policies Include Unfunded Mandates and Restrictions on State Taxation

The report describes four types of federal policies that are harming states:

• Recent federal tax cuts.   Some of the federal tax cuts enacted in 2001, 2002, and 2003 are reducing state revenues because of linkages between the federal and state tax codes.

• Federal restrictions on state sales taxing authority.  Federal law bars states from taxing access fees for Internet service.  Also, two Supreme Court decisions prevent states and localities from collecting sales taxes on most catalog and Internet purchases.

• Unfunded mandates.  In areas such as the No Child Left Behind education law, the federal government has imposed new requirements on state and local governments without providing adequate funding.

• Shifting health care costs.   In recent decades, some of the cost of caring for low-income elderly and disabled people has shifted from Medicare (which is fully federally funded) to Medicaid (where states pay nearly half of all costs) because Medicaid includes prescription drug coverage but Medicare does not.  Under the recent Medicare bill, Medicare will begin providing drug coverage to these individuals in 2006, but states are required to return the bulk of their savings to the federal government.

The combined cost of these policies — $175 billion over fiscal years 2002-2005 — dwarfs the $20 billion in federal fiscal relief that was enacted in 2003.

Poorest States Among Those Hardest Hit

Federal policies have hurt some states much more than others.  (The attached table from the report lists the impact on each state.)  Among the hardest hit are many of the poorest states, states that rely heavily on federal grants to fund education and other programs, and states in which sales taxes are the predominant revenue source.

Extending Tax Cuts for Wealthy the Top Priority?

The 2001-2003 tax cuts are scheduled to phase out over the next several years.  If they are extended, as the Administration and some in Congress favor, the federal government will face large budget deficits for the foreseeable future.  That would effectively prevent Washington from adopting more equitable policies toward the states.

“It comes down to a choice between continuing all of the large tax cuts for high-income households and moderating those tax cuts so the federal government can fix the policies that harm state budgets,” said Lav.  “At bottom, this is a question of which is the higher national priority.”

Click here to view the full report, Passing Down the Deficit: Federal Policies Contribute to the Severity of the State Fiscal Crisis.

The Center on Budget and Policy Priorities is a nonprofit, nonpartisan research organization and policy institute that conducts research and analysis on a range of government policies and programs.  It is supported primarily by foundation grants.