Many States Face Revenue Shortfalls
States Can Take Steps to Strengthen Their Tax Systems and Reserves
March 30, 2017
In 2017, 25 states are facing or have addressed revenue shortfalls.During times of economic growth, states can be reasonably confident that the tax collections upon which they base their budgets will come in as predicted. This year is different, however. In 2017, 25 states are facing or have addressed revenue shortfalls. More states expect mid-year revenue shortfalls than in any year since 2010, according to the National Association of State Budget Officers.
The mid-year revenue shortfalls and resulting budget problems — some of which are due to state policymakers’ own ill-advised tax policy choices — that states are facing in 2017 appear to be the first signs of continuing problems. More than half the states lack the revenue needed to maintain services at existing levels in 2018. All told, two-thirds of the states are facing or have addressed revenue shortfalls this year, next year, or both. (See Figure 1 and Table 1.)
States cut spending, increase revenues, or tap rainy day funds or other reserves to close budget gaps and maintain a balanced budget, which all states do because of laws or tradition. So far in 2017, states have used reserve funds and spending cuts to balance their budgets. But policymakers in some states, such as Kansas and Alaska, are considering tax increases for next year.
While states cannot control all of the factors contributing to their budget uncertainty — for example, potential cuts to federal grants that comprise nearly a third of their budgets — they can take a number of steps now to strengthen their tax systems and reserves that will protect revenues in the coming years.
Slowing Revenues Are Adding to Budget Uncertainty
Despite the continued national economic recovery, state revenue growth is slowing for a number of reasons, including:
- Falling energy prices. States with energy-based economies have seen energy-related taxes plummet as oil prices have dropped. States with the greatest reliance on energy taxes like Alaska, Louisiana, Oklahoma, and West Virginia have struggled with budget problems since oil prices began to fall in 2014.
- Tax cuts. Costly and ill-advised tax cuts enacted in recent years are suppressing some states’ tax collections. For example, 11 states have enacted large, phased-in tax cuts since 2011 that will cost a combined $8 billion a year once fully implemented.
- Stock market growth. Sluggish stock market growth in 2015 and the beginning of 2016 slowed income tax collections. The stock market rebounded starting in late 2016, but income tax collections are now lagging expectations as wealthy taxpayers appear to be postponing selling stocks and other assets in the hope that President Trump and Congress will cut capital gains tax rates. Some 23 states reported declines in estimated income tax payments in January compared to the prior year, according to the Rockefeller Institute of Government. (Estimated tax payments are made by taxpayers who receive income like capital gains from stock sales that are not subject to withholding like wages.)
- Slower-than-average sales tax collections. Despite the economic recovery, sales tax collections are below their historical average as consumers have remained cautious long after the end of the recession and untaxed Internet sales have continued to grow.
Slowing revenues are just one element of uncertainty about how states will be able to meet their responsibilities. Federal grants to states — which make up approximately 31 percent of state budgets — are at risk of being cut based on proposals from President Trump and congressional Republicans, though at this stage in the federal budget process it is unclear how deep these cuts may be.
The prospect of changes to the federal tax system, as President Trump and congressional Republicans intend to propose, could also have major state revenue implications. Most state income taxes are based on federal definitions of income. Increases in certain deductions, such as allowing immediate expensing of the full cost of investments, could result in state revenue losses. The elimination of the federal estate tax could make it more difficult for states with estate taxes to retain them. On the other hand, broadening the base to make more income taxable to offset federal rate cuts could modestly increase state revenues.
How States Should Respond
To prevent and cope with revenue slowdowns that are leading to budget problems, states should:
Avoid ineffective tax cuts and incentives that would deplete revenues and worsen budget problems. Several states have enacted or considered deep income tax cuts that give the largest benefits to large, profitable corporations and the highest-income people. Such proposals not only typically 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 depleting budget reserves while the economy continues to grow and, if possible, build budget reserves to protect public investment and limit the damage from recessions. “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.
Rainy day reserves will be particularly important for states to cope with reduced state revenues if the federal government plays a smaller role during future economic downturns. For example, proposals to cut federal support for low-income health care or food assistance through fixed funding (block grants) or other types of caps would make these programs less responsive to economic downturns.
Begin now to plan for revenue replacements to offset the potential future loss of federal support. Maintaining and improving schools, affordable housing, job training, and other public services shown to generate growth will require resources, both now and in the future. President Trump and congressional Republicans have proposed steep cuts in federal support for programs and services delivered by states and localities. For example, the President’s budget would cut state and local discretionary grants by $18 billion in 2018. These federal grants include support for education, including support for low-income students and students with special needs, and programs to subsidize housing for low-income families and seniors and foster community development.
To make up the difference if these cuts are enacted, states should consider raising their own revenues. 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.
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. They are especially problematic in uncertain times like this. States will need flexibility, not strict limits like TABOR, to raise revenues or increase their own support for programs and services to respond to likely cuts in federal funding over the next few years.
Address structural problems in state revenue systems. Antiquated tax systems ill-suited to the 21st century economy hamper states’ ability to restore school funding, cope with cuts in federal support, 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 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. In addition, states should diversify revenue sources, including sales, excise and/or income taxes, each of which responds differently to economic changes, to improve the stability of tax collections.
Revenue Shortfalls Aren’t the Only Measure of Budget Problems
This report focuses on states where revenues are falling short of the amount expected or of the amount needed to maintain current services. (See note at the end of Table 1.) Other states that do not appear in our count and on the list in Table 1 are also at risk of failing to provide the investments needed to grow the state economy now or in the future. For example, some states have chronically underfunded education, health care, transportation, and other services or rely on tax systems with structural problems that are not yet evident. In addition, many states do not regularly publish estimates of the cost of maintaining current services, making it difficult to identify shortfalls in future budgets.
|States Facing Shortfalls in Fiscal Years 2017 and 2018|
|State||FY17 Revenue Shortfalls, millions||% General Fund*||FY18 Projected Budget Shortfall, millions||% General Fund*|
|Sources for Shortfall Information in Table 1|
|Alabama||None||Arise Citizens Policy Project|
|Alaska||Alaska Senate Finance Committee, Legislative Finance Division||Alaska Division of Legislative Finance|
|California||California Legislative Analyst’s Office||Los Angeles Times|
|Colorado||Governor’s Office of State Planning and Budgeting, Colorado Legislative Council Staff, Economics Section||Governor’s Office of State Planning and Budgeting, Colorado Legislative Council|
|Connecticut||Connecticut Office of Fiscal Analysis, State of Connecticut Comptroller||Connecticut Office of Policy and Management|
|Delaware||State of Delaware Department of Finance||Delaware News Journal|
|Hawaii||State of Hawai’i Department of Budget and Finance||None|
|Illinois||Illinois Office of Management and Budget||Illinois Office of Management and Budget|
|Iowa||Iowa Legislative Services Agency||None|
|Kansas||Kansas City Star||Kansas Center for Economic Growth|
|Louisiana||Louisiana Office of the Governor||Joint Legislative Committee on the Budget|
|Maryland||State of Maryland Board of Revenue Estimates||Spending Affordability Committee|
|Massachusetts||State House News Service||Massachusetts Budget and Policy Center|
|Minnesota||Minnesota Management and Budget||Minnesota Management and Budget|
|Mississippi||Daily Journal Jackson Bureau||Mississippi Today|
|Missouri||St. Louis Post-Dispatch||Missouri Budget Project|
|Montana||Montana Legislative Fiscal Division||Montana Legislative Fiscal Division|
|Nebraska||Nebraska Legislature||Nebraska Legislature|
|New Jersey||State of New Jersey Department of the Treasury, New Jersey Office of Legislative Services||None|
|New Mexico||Albuquerque Journal, New Mexico Legislature Legislative Finance Committee||New Mexico Legislature Legislative Finance Committee|
|New York||Office of the New York State Comptroller||New York Division of Budget|
|North Dakota||Grand Forks Herald||None|
|Oklahoma||Oklahoma Office of Management and Enterprise Services||Oklahoma State Board of Equalization|
|Oregon||State of Oregon Legislative Fiscal Office/Department of Administrative Services||Legislative Fiscal Office|
|Pennsylvania||Pennsylvania Independent Fiscal Office||Pennsylvania Independent Fiscal Office|
|Rhode Island||State of Rhode Island Revenue Estimating Conference||WPRI|
|South Dakota||South Dakota Budget and Policy Institute||None|
|Vermont||Vermont Agency of Administration||Vermont Agency of Administration|
|Virginia||The Commonwealth Institute||The Commonwealth Institute|
|Washington||Washington State Economic and Revenue Forecast Council||Washington Budget & Policy Center|
|West Virginia||West Virginia State Budget Office||West Virginia State Budget Office|
|Wyoming||Wyoming Consensus Revenue Estimating Group||Wyoming Tribune-Eagle|
 National Association of State Budget Officers, “Fiscal Survey of the States,” Fall 2016, http://www.nasbo.org/reports-data/fiscal-survey-of-states.
 Lucy Dayadan and Donald J. Boyd, “State Revenue Report #106: Weak Tax Revenue Growth in The Third and Fourth Quarters of 2016 Amid Uncertainty About Federal Tax Changes,” Rockefeller Institute of Government, March 2017, http://www.rockinst.org/pdf/government_finance/state_revenue_report/2017-03-09-srr_106.pdf.
 Elizabeth McNichol and Erica Williams, “Extracting Lessons for State Finances: What Other States Should Learn from Energy-Producing States’ Revenue Woes,” Center on Budget and Policy Priorities, February 14, 2014, http://www.cbpp.org/research/state-budget-and-tax/extracting-lessons-for-state-finances.
 Eric Figueroa, Michael Leachman, and Michael Mazerov, “Phasing in State Tax Cuts Doesn’t Make Them Fiscally Responsible,” Center on Budget and Policy Priorities, February 6, 2017, http://www.cbpp.org/research/state-budget-and-tax/phasing-in-state-tax-cuts-doesnt-make-them-fiscally-responsible.
 Dayadan and Boyd.
 Iris J. Lav and Michael Leachman, “At Risk: Federal Grants to State and Local Governments,” Center on Budget and Policy Priorities, March 13, 2017, http://www.cbpp.org/research/state-budget-and-tax/at-risk-federal-grants-to-state-and-local-governments.
 For more detail on these suggestions, see Erica Williams, “A Fiscal Policy Agenda for Stronger State Economies,” Center on Budget and Policy Priorities,” updated April 13, 2016, http://www.cbpp.org/research/state-budget-and-tax/a-fiscal-policy-agenda-for-stronger-state-economies.
 Elizabeth McNichol, “When and How States Should Strengthen Their Rainy Day Funds,” Center on Budget and Policy Priorities, April 17, 2014, http://www.cbpp.org/research/state-budget-and-tax/when-and-how-states-should-strengthen-their-rainy-day-funds.
 Iris J. Lav, “Trump Budget Slashes State and Local Grants at Tough Time for States,” Center on Budget and Policy Priorities, March 17, 2017, http://www.cbpp.org/blog/trump-budget-slashes-state-and-local-grants-at-tough-time-for-states.
 “Policy Basics: Taxpayer Bill of Rights (TABOR),” Center on Budget and Policy Priorities, updated August 13, 2015, http://www.cbpp.org/research/state-budget-and-tax/policy-basics-taxpayer-bill-of-rights-tabor.
 Michael Leachman and Michael Mazerov, “Four Steps to Moving State Sales Taxes Into the 21st Century,” Center on Budget and Policy Priorities, July 9, 2013, http://www.cbpp.org/research/state-budget-and-tax/four-steps-to-moving-state-sales-taxes-into-the-21st-century?fa=view&id=3987.