Strengthening State Budgets for the Long Haul

States face serious long-term problems that could slowly undermine their ability to fund education, health care, infrastructure, and other critical needs — just at the time when recovering revenues should be allowing them to start restoring the deep cuts of recent years.

A new report from a task force convened by former New York Lieutenant Governor Richard Ravitch and former Federal Reserve Chairman Paul Volcker discusses these problems, several of which we explored some years ago in our

These structural problems aren’t an immediate crisis requiring radical action; state budgets are slowly recovering from the severe damage inflicted by the Great Recession.  But there are a number of important steps that states can and should take, including:

• Strengthening their revenue systems. Household spending has been shifting from goods to services for decades, yet only a few states apply their sales taxes to a broad array of services.  States and localities can halt the long-term erosion of sales tax revenues by broadening their sales tax bases to include more services.

  The rise of e-commerce is also weakening state sales taxes because the Supreme Court has ruled that states can’t require businesses to collect the sales taxes consumers legally owe on purchases from out-of-state sellers.  But the Court left the door open for Congress to address this problem, and it’s time for federal lawmakers to enact a bill that would enable states to tax sales over the Internet.

  More progressive taxes like income taxes could help, as well.  Income growth in the wake of the Great Recession appears to be following the pattern of recoveries after other recent recessions, in which the incomes of the wealthy recover well before those of low- and middle-income people.  Thus, states that have robust income taxes with graduated rates can make a speedier recovery and be better able to address important needs in the future by harnessing economic gains that flow disproportionately to the wealthy.  At the same time, states should maintain a mix of different types of taxes, including sales and excise taxes, to reduce the likelihood that all will fall simultaneously.

• Maintaining adequate reserves. The roller-coaster economy of the last decade has highlighted the importance of state “rainy day funds” — budget reserves designed to respond to unexpected revenue declines or spending increases caused by recessions or other events.  States should significantly expand their rainy day funds; they should set money aside when taxes are growing well so they are better able to weather future cyclical downturns.
• Making the budget process more transparent. Good budget information will be critical to determining the needed reforms and building support for them, as the task force notes.  To make clear the impact of proposed policy changes, states that don’t already do so should prepare current services budgets, which show the cost of maintaining programs in their current form.States should also strengthen their tax expenditure reports, which list the state’s tax exemptions and credits (everything from poverty-reducing tax credits to middle-class benefits to corporate subsidies) and how much each one costs, along with other information that helps policymakers decide whether they are worth continuing.And states should consider adopting “pay-as-you-go” (PAYGO), which requires policymakers to offset the cost of tax cuts or spending increases for each of the next five years.  PAYGO could head off changes that would worsen structural problems, like relying on one-time revenues for permanent tax and spending changes.

In a followup post, we’ll clear up some common misconceptions about the role of Medicaid in state budgets.