A Fiscal Policy Agenda for Stronger State Economies
April 13, 2016
With most state legislatures now in session, policymakers are making fiscal policy decisions that will profoundly affect future economic opportunities in communities across the country. States face a fundamental choice: they can provide the resources required for public investment in schools, transportation, health care, safe communities, and other building blocks of economic growth, or go down the path of tax cuts and skimping on public investment. States have many tools at their disposal to promote economic opportunity. When it comes to the former, states have many tools at their disposal to promote economic opportunity.
After recession hit the states in 2008, record-breaking revenue declines brought deep, job-killing cuts to schools, health care, and other key services that people depend on every day. State revenues have since come back somewhat. While that growth has been slow and uneven, it enables states to both make up lost ground and meet rising needs, including keeping up with growing enrollment in K-12 schools and public colleges and universities — if they choose to.
This report provides a roadmap to fiscal policies that can help create jobs now and prime states for long-term, broadly shared prosperity. Each section links to CBPP analyses describing the options in more detail. The overarching message is that policymakers should:
- Target public investments to boost the economy, now and in the future;
- Help struggling families meet basic needs and participate more fully in the economy, by reducing poverty, hardship, and income inequality;
- Avoid ineffective strategies and gimmicks like costly tax cuts and artificial spending limits, which can weaken a state’s economy;
- Improve fiscal planning to protect services and investments that promote long-term economic growth; and
- Raise revenues to make critical investments when necessary.
1. Make Targeted Public Investments
States can build a strong foundation for economic growth and promote jobs that enable people to do more than just make ends meet. For example, public investment in education, transportation, and fire protection — services that businesses rely on heavily — can create jobs in the short run and improve economic growth and job quality in the long run.
States’ resources are limited. As lawmakers grapple with difficult decisions about how much to invest in schools and roads and whether to pursue new opportunities in areas such as early education and job training, they should keep in mind that the benefits in many cases outweigh the costs.
Rebuild and strengthen education. Most states provide less support per student for K-12 schools than before the recession hit, and nearly half of the states provide less support per student for public colleges and universities. States should reinvest in education, sustaining (and, where possible, expanding) these investments in the future economy. For example, research shows that some types of education and training have high “bang for the buck.” High-quality preschool improves not only children’s academic performance but also the quality of a state’s workforce and jobs over time; the increased earnings alone outweigh the costs by more than five times, one study found. Likewise, customized job training focused on the basic skills sought by local employers has been shown to produce substantial payoffs.
Restore infrastructure. Reversing the serious decline in state investment in transportation, public buildings, water treatment, and other forms of vital infrastructure is key to creating jobs and promoting full economic recovery — and this is an especially good time to do it, given today’s low interest rates. The condition of roads, bridges, schools, and other physical assets greatly influences the economy’s ability to function and grow. Commerce requires well-maintained roads, railroads, airports, and ports so that manufacturers can obtain raw materials and parts and deliver finished products to consumers. Growing communities rely on well-functioning water and sewer systems. Also, well-maintained schools free from crowding and safety hazards improve educational opportunities for future workers.
Support entrepreneurs. States should target their economic development resources where most future jobs will come from. That means producing more home-grown entrepreneurs and helping startups and young, fast-growing firms already located in the state to survive and to grow ― not on cutting taxes and trying to lure businesses from other states. The vast majority of jobs are created by businesses that start up or are already present in a state, our analysis finds — not by out-of-state firms that relocate or branch into a state. Economic development policies that ignore these realities are unlikely to succeed. Deep income tax cuts, for example, fail to produce the promised economic benefits, and they take money away from education and other public investments essential to producing the talented workforce and quality of life that entrepreneurs require.
Make careful spending decisions. States can free up funds for the above priorities by reviewing other spending areas that may not be meeting intended goals. While the savings from finding efficiencies are usually modest, some areas hold particular promise. A number of states, for example, have implemented criminal justice reforms that save money without compromising public safety. States can also better monitor and evaluate economic development subsidies and eliminate those that are ineffective.
More broadly, states should scrutinize the billions of dollars they spend each year through the tax code in the form of credits, deductions, and exemptions. For the most part, policymakers don’t regularly examine these “tax expenditures” for effectiveness the way they examine yearly budget appropriations. They also should evaluate their contracting practices, potentially saving money by reducing reliance on consultants.
2. Help Struggling Families Share in Prosperity
Unevenly shared prosperity that promotes the concentration of economic gains among the richest households limits opportunity for the broad majority. Millions of families struggle to make ends meet because their jobs pay too little or offer inadequate, unpredictable, and inflexible schedules. Many others struggle because of employment barriers that are difficult or impossible to overcome, like a disability or criminal record.
This holds back state economies, now and in the future. Not only does it weaken the purchasing power of poor and middle-class families, who spend all or most of what they earn, but extreme income inequality left unaddressed and lack of economic mobility make economic growth less sustainable. Limited opportunity affects children in particular. Children in poor families not only perform less well in school than their better-off counterparts, but also likely earn less as adults. Forgone earnings and other side effects of child poverty create a substantial drag on the economy over the long run.
State policymakers should redouble efforts to help struggling families and avoid cutting supports that ease hardship. They also should reform policies in areas such as immigration and criminal justice that carry unnecessary economic costs, with the goal of helping more people participate more fully in the economy.
- Boost the earnings of working families. Twenty-six states and the District of Columbia have enacted state-level Earned Income Tax Credits (EITC) to help working families earning low wages meet basic needs. State EITCs build on the success of the federal EITC by keeping working parents on the job and families and children out of poverty. This important state support also extends the federal EITC’s well-documented, long-term positive effects on children, boosting the nation’s future economic prospects. States can also help promote family economic stability by raising their minimum wage. In fact, increases in state EITCs and minimum wages work best together; it’s not an either-or choice.
See: States Can Adopt or Expand Earned Income Tax Credits to Build a Stronger Future Economy
How Much Would a State Earned Income Tax Credit Cost in Fiscal Year 2017?
State Earned Income Tax Credits and Minimum Wages Work Best Together
EITC and Child Tax Credit Promote Work, Reduce Poverty, and Support Children’s Development, Research Finds
Protect and better administer supports for the neediest, especially children. Families turn to public assistance when they aren’t paid enough to get by, are unemployed, need to care for a sick child, or face a crisis such as fleeing an abusive relationship. Many also face serious mental or physical health problems. States should maintain cash assistance and other supports like child care and transportation subsidies, funded by federal and state dollars, to help these families meet basic needs and find and keep jobs. Also, ample opportunities exist to strengthen other supports for low-income families that require little to no additional state funding. For example, initiatives to boost participation in SNAP — a program that lifts 10 million people out of poverty — carry little state cost since SNAP benefits are fully federally funded. School districts can provide free school meals to more low-income children through the federal Community Eligibility Provision. State agencies can streamline access to these and other key safety net supports like Medicaid so that children and families are connected to all of the programs for which they’re eligible without duplicative application processes. And states can adopt and enforce anti-discrimination laws to protect families with housing vouchers and help them move to higher-opportunity neighborhoods.
See: State Temporary Assistance for Needy Families Programs Do Not Provide Adequate Safety Net for Poor Families
Community Eligibility Adoption Rises for the 2015-2016 School Year, Increasing Access to School Meals
New State Option Can Cut Red Tape and Boost Medicaid Enrollment
Safety Net More Effective Against Poverty Than Previously Thought
Realizing the Housing Voucher Program’s Potential to Enable Families to Move to Better Neighborhoods
Help struggling residents — and the state — by expanding Medicaid. Health reform gives states the option of extending Medicaid coverage to people with incomes up to 138 percent of the poverty line. This reduces the ranks of the uninsured, protects families against health-related financial shocks, and keeps people healthier and able to work. It also brings substantial federal funds to the state, since the federal government will pay the full cost of the expansion through 2016 and nearly all costs after that. For states that have been using their own funds to provide health coverage and services to people ineligible for Medicaid, this option should be particularly attractive because it enables them to use federal money to help cover existing costs, freeing up state funds for other priorities.
Reform criminal justice policies. State policy reforms can produce significant savings and enable marginalized members of society to participate more fully in the economy. For example, some states have chosen effective addiction treatment instead of incarceration for people convicted of drug-related crimes. Others use sanctions rather than prison time for people who violate the technical conditions of their parole, like missing a meeting with their parole officer. These reforms have saved states millions of dollars without endangering public safety. They also have reduced recidivism and given many people a better chance to become productive members of society.
Bring unauthorized immigrants into the mainstream economy. States can avoid the unnecessary social, economic, and financial costs of detaining unauthorized immigrants by leaving immigration enforcement to federal agencies. Instead, state policymakers can adopt more inclusive approaches that bring unauthorized immigrants into the mainstream economy, build a more educated and productive workforce, and allow immigrants to contribute to their fullest. For example, states can strengthen enforcement of labor laws to ensure that all workers, including unauthorized immigrants, receive the wages they are legally owed.
3. Avoid Ineffective Strategies and Gimmicks
Several states have enacted or considered deep income tax cuts that give the largest benefits to large, profitable corporations and the highest-income people. Others have weighed budget restrictions that would severely limit state investments. Such proposals not only fail to produce the promised economic benefits but also squander revenue that states could otherwise use to lay a strong foundation for future economic growth by investing in high-quality schools, infrastructure, and the like. They also make it harder for states to save for a rainy day or respond to changing circumstances.
Avoid costly income tax cuts. Some policymakers have proposed extreme tax changes, such as replacing the state’s income tax with a higher, broader sales tax. That would sharply raise taxes for low- and middle-income households and threaten a state’s ability to maintain many of the services necessary for a strong economy. Other proposals would eliminate or deeply cut income taxes for individuals and businesses without replacing the lost revenues, forcing drastic cuts in services like schools, transportation, and public safety.
Many states have enacted less extreme but still deep income tax cuts that benefit individuals at the top and profitable businesses but do little or nothing for low- and middle-income households and damage states’ ability to invest in more effective ways.
See: State Personal Income Tax Cuts: Still a Poor Strategy for Economic Growth
Lessons for Other States from Kansas’ Massive Tax Cuts
Fact Sheet: Tax Cuts Don’t Boost Small Business Employment
Fact Sheet: Why Cutting State Income Taxes Isn’t the Way to Attract Residents
Fact Sheet: Big Cuts in State Income Taxes Not Yielding Promised Benefits
Academic Research Lacks Consensus on the Impact of State Tax Cuts on Economic Growth
ALEC Tax and Budget Proposals Would Slash Public Services and Jeopardize Economic Growth
“FairTax” Proposals to Replace State Income and Business Taxes With Expanded Sales Tax Would Create Serious Problems
Avoid costly corporate tax cuts. Large corporate tax breaks typically do little, if anything, to spur economic growth. Most are a zero-sum game at best: if a state cuts a tax, it generally has to make an offsetting cut to a program or service to keep its budget balanced; the spending cut will likely reduce demand in the state just as much as the tax cut may have stimulated demand. State film tax credits are one example. Film companies receive generous tax benefits in many states for creating largely temporary and part-time jobs that they might have created anyway, while people who rely on other forms of state spending take the hit.
See: Cutting State Corporate Income Taxes Is Unlikely to Create Many Jobs
The Zero-Sum Game: States Cannot Stimulate Their Economies by Cutting Taxes
State Film Subsidies: Not Much Bang For Too Many Bucks
Reject artificial spending limits. Strict, arbitrary formulas to limit revenues and spending, like Colorado’s “Taxpayer Bill of Rights” or TABOR, may sound appealing but are gimmicks that hamstring a state’s ability to adapt to changing needs and voter demands. Since Colorado adopted TABOR in 1992, every other state that has considered a TABOR has rejected it because it requires massive reductions in support for vital services that residents want and need, such as education, health care, public safety, transportation, and environmental protection.
Reject supermajority restrictions. Requiring a legislative supermajority or voter approval for bills that raise revenue makes it harder for states to protect public investments during recessions. The resulting cuts can cost jobs and weaken an economic recovery. These restrictions typically reduce a state’s ability to repeal costly and wasteful tax loopholes, as well. They can also damage a state’s bond rating and cause legislative gridlock: because a small minority of lawmakers can block a tax measure, they can hold it hostage to enactment of expensive pet projects, making it harder to enact policies that serve the state as a whole.
See: Six Reasons Why Supermajority Requirements to Raise Taxes Are a Bad Idea
A “Super” Bad Idea: Requiring a Two-thirds Legislative Supermajority to Raise Taxes Protects Special Interest Tax Breaks and Gives Budget Veto Power to a Small Minority of Legislators
4. Improve Fiscal Planning
The more accurate and useful information states have, the better decisions they can make about allocating resources. Policymakers can better plan for the future by laying out a clear budget roadmap, ensuring that budget impact analyses are professional and credible, and instituting mechanisms that trigger needed mid-year changes when needed to keep the state on course. For an overview see: Budgeting for the Future: Fiscal Planning Tools Can Show the Way.
Create better cost estimates. Policymakers need accurate information about the cost of spending- and tax-related proposals to make informed decisions. Nearly all states produce some sort of cost estimate of legislative proposals, typically called a “fiscal note,” but these estimates often fail to extend beyond the next year or two, are not revised when the legislation is amended, or are only produced for a narrow set of bills. This lack of information can cause policymakers to enact proposals that cause serious fiscal problems.
Employ best practices in budget planning. States routinely put at risk some of their highest priorities ― educating children, maintaining a healthy and trained workforce, and caring for the elderly, for example ― by failing to employ proven budget methods that would help them plan further into the future. Getting a stronger grasp of likely revenues and the cost of providing core services would help ensure that states have the resources to invest in schools and other building blocks of strong economic growth and widespread prosperity. Better planning also can help businesses by reducing their uncertainty about future funding levels and tax rates.
Strengthen “rainy day” funds. “Rainy day” reserve funds to help states offset revenue declines during economic downturns are crucial to prudent fiscal management. In hard times, policymakers can tap them to protect state investments that promote economic growth and sustain the state’s demand for private-sector goods and labor. States without such funds should create them; states with arbitrary or onerous restrictions on their use should reform them.
Institute “pay-as-you-go.” With an improving economy, many policymakers are tempted to cut taxes in ways that will damage their state’s ability to maintain public investments over the long term. States also may be tempted to enact new programs that are not sustainable without significant new revenue. States can protect themselves against these possibilities by adopting “pay-as-you-go” (PAYGO), a requirement that policymakers fully offset over a five-year period the cost of proposed and enacted spending increases or revenue reductions. PAYGO helps policymakers and the public understand the consequences of budget decisions and tax cuts so they can properly weigh the long-term impact of competing proposals.
5. Raise Revenue Needed for Economy-Boosting Investments
Public discussions about strengthening the economy often center on tax cuts, despite growing evidence that they don’t create many jobs or promote broad prosperity. Maintaining and improving schools, transportation networks, and other public services shown to generate growth will require resources, both now and in the future. States should pursue new revenue where necessary and modernize their revenue systems for the long term.
Pursue focused tax increases. State revenues have finally returned to pre-recession levels but remain inadequate in many states. Tax increases on high-income individuals and profitable corporations (those best able to afford the higher tax and least likely to spend substantially less as a result) typically are preferable to spending cuts. This is especially true when the cuts in question could weaken the underpinnings of a sound economy — a high-quality education system, access to college, and modern transportation networks, for example.
Policymakers can raise taxes on high-income households and profitable corporations by changing the state income tax and reinstating taxes on inherited wealth. Evidence doesn’t support the frequent claim that these kinds of tax increases will drive large numbers of affluent people to other states.
See: Fact Sheet: Debunking the Myth that Raising Taxes on the Rich Will Harm a State’s Economy
Many States Tax Inherited Wealth
State Taxes Have a Negligible Impact on Americans’ Interstate Moves
Raising State Income Taxes on High-Income Taxpayers
Improve tax collections. States can do a better job of collecting taxes due under current law rather than reduce support for services. For example, the failure of catalogue or Internet sellers to collect and remit state and local sales taxes costs states billions of dollars each year. Similarly, many states don’t require online travel companies like Expedia, Orbitz, and Priceline to collect and remit the appropriate tax on hotel room bookings. States also can nullify a variety of tax-avoidance strategies employed by large multistate corporations by adopting “combined reporting,” which treats a parent company and its subsidiaries as one entity for state income tax purposes.
See: States Get New Tool to Collect Taxes Due on Internet Sales
State and Local Governments Should Close Online Hotel Tax Loophole and Collect Taxes Owed
A Majority of States Have Now Adopted a Key Corporate Tax Reform — “Combined Reporting”
New York’s “Amazon Law”: An Important Tool for Collecting Taxes Owed on Internet Purchases
Modernize state revenue systems. Antiquated tax systems ill-suited to the 21st century economy hamper states’ ability to restore school funding, rebuild budget reserves, and invest in the future. For instance, many states primarily levy sales taxes on tangible goods, even though services — many of which didn’t exist when sales taxes were first enacted, such as video streaming — make up a growing share of consumption. States can halt the erosion of their sales taxes and improve their long-term ability to invest in state priorities by broadening the sales tax to include more services.
See: Four Steps to Moving State Sales Taxes Into the 21st Century
States Should Embrace 21st Century Economy by Extending Sales Taxes to Digital Goods and Services
Expanding Sales Taxation of Services: Options and Issues
 Elizabeth McNichol, “Out of Balance,” Center on Budget and Policy Priorities, April 18, 2012, http://www.cbpp.org/cms/?fa=view&id=3747. When states cut services, they end contracts with private-sector businesses and reduce spending on private-sector goods, leading to layoffs or lower wages among private-sector workers. These cuts can also mean layoffs for teachers, firefighters, police officers, and other public-sector workers; states and localities have shed 308,000 jobs since December 2007. In turn, private- and public-sector workers facing layoffs or pay cuts buy less, which reduces economic activity further.
 Timothy Bartik, “State Economic Development Policies: What Works?,” presented at the 19th Annual State Fiscal Policy Conference, Center on Budget and Policy Priorities, Washington, D.C., November 30, 2011, http://research.upjohn.org/presentations/27/; Peter S. Fisher, “Corporate Taxes and State Economic Growth,” Iowa Fiscal Partnership, revised February 2012, http://www.iowafiscal.org/2011docs/110209-IFP-corptaxes.pdf; Jeff Thompson, “Prioritizing Approaches to Economic Development in New England: Skills, Infrastructure, and Tax Incentives,” Political Economy Research Institute, U. of Mass., 2010, http://www.peri.umass.edu/fileadmin/pdf/published_study/priorities_August9_PERI.pdf; and Robert G. Lynch, “Rethinking Growth Strategies: How State and Local Taxes and Services Affect Economic Development,” Economic Policy Institute, 2004, http://epi.3cdn.net/f82246f98a3e3421fd_o4m6iiklp.pdf.
 Timothy Bartik, “From Preschool to Prosperity: The Economic Payoff to Early Childhood Education,” W.E. Upjohn Institute for Employment Research, 2014, http://research.upjohn.org/cgi/viewcontent.cgi?article=1246&context=up_press.
 Bartik, 2011, and Timothy Bartik, “Bringing Jobs to People: How Federal Policy Can Target Job Creation for Economically Distressed Areas,” Brookings Institution, October 2010, http://www.brookings.edu/~/media/Files/rc/papers/2010/10_job_creation_bartik/10_job_creation_bartik.pdf.
 See Chad Stone et al., “A Guide to Statistics on Historical Trends in Income Inequality,” Center on Budget and Policy Priorities, updated October 26, 2015, http://www.cbpp.org/research/poverty-and-inequality/a-guide-to-statistics-on-historical-trends-in-income-inequality and Elizabeth McNichol et al., “Pulling Apart: A State-by-State Analysis of Income Trends,” Center on Budget and Policy Priorities and Economic Policy Institute, November 15, 2012, http://www.cbpp.org/research/poverty-and-inequality/pulling-apart-a-state-by-state-analysis-of-income-trends.
 See, for instance, Andrew G. Berg and Jonathan D. Ostry, “Equality and Efficiency,” Finance & Development, Vol. 48, No. 3, September 2011, http://www.imf.org/external/pubs/ft/fandd/2011/09/pdf/berg.pdf and Jonathan D. Ostry, Andrew Berg, and Charalambos G. Tsangarides, “Redistribution, Inequality, and Growth,” International Monetary Fund, February 2014, http://www.imf.org/external/pubs/ft/sdn/2014/sdn1402.pdf.
 Greg J. Duncan and Katherine Magnuson, “The Long Reach of Early Childhood Poverty,” Pathways, Winter 2011, http://www.stanford.edu/group/scspi/_media/pdf/pathways/winter_2011/PathwaysWinter11_Duncan.pdf. Job losses during the recession exacerbated poverty and hardship for children, which means even greater future costs to individuals, families, and state economies.
 Harry Holzer et al., “The Economic Costs of Poverty in the United States: Subsequent Effects of Children Growing Up Poor,” Center for American Progress, 2007, http://cdn.americanprogress.org/wp-content/uploads/issues/2007/01/pdf/poverty_report.pdf.
 Michael Mazerov, “Academic Research Lacks Consensus on the Impact of State Tax Cuts on Economic Growth,” Center on Budget and Policy Priorities, June 17, 2013, http://www.cbpp.org/cms/index.cfm?fa=view&id=3975; Erica Williams and Nicholas Johnson, “ALEC Tax and Budget Proposals Would Slash Public Services and Jeopardize Economic Growth,” Center on Budget and Policy Priorities, February 12, 2013, http://www.cbpp.org/cms/index.cfm?fa=view&id=3901; Peter Fisher, Greg Leroy, and Phillip Mattera, “Selling Snake Oil to the States,” Good Jobs First and Iowa Policy Project, November 2012, http://www.iowafiscal.org/2012docs/121128-snakeoiltothestates.pdf.