December 13, 2001


Proposal Would Require States to Make Additional Spending Cuts
and Tax Increases, Worsening Recession

by Nicholas Johnson

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As state governments face their worst fiscal crisis in at least two decades, the Bush Administration yesterday proposed legislation that would make the state fiscal crisis substantially worse than it already is. The Administration's "framework for fiscal recovery" includes business tax provisions that would reduce state revenue by about $5 billion per year beginning immediately. At the same time, the Administration plan fails to include any direct fiscal relief to states, thereby missing an opportunity to provide one of the most effective forms of economic stimulus.

New estimates from state budget officials show that state deficits for the current year equal or exceed $40 billion, an amount that includes at least $35 billion in revenue shortfalls and higher-than-expected spending on countercyclical programs such as Medicaid, plus an additional $5 billion in unanticipated spending on homeland security. These deficits are widespread. Because not all states yet have estimated the size of their budget deficits, and because state economies are expected to worsen as unemployment continues to rise, the National Governors Association projects that shortfalls for the current fiscal year could rise to $50 billion or nearly 10 percent of state budgets, a much larger shortfall than in even the worst year of the last recession.

The Administration proposal would increase those shortfalls. The Congressional Research Service estimates that the provision known as "bonus depreciation" or "immediate expensing," which would allow corporations to write off a portion of business equipment purchases immediately rather than spreading them over several years, would cost state governments $5.4 billion in the current fiscal year, $5.1 billion in FY 2003, and $4.2 billion in FY 2004. Some states would lose additional revenue as a result of two other corporate tax provisions in the Administration proposal: the provision for net operating loss carryback and any reductions in the corporate alternative minimum tax.

These losses would occur because some 44 states use the federal rules on expensing and depreciation in the calculation of their own state corporate and other business income taxes; these 44 states would experience significant state revenue losses if this provision becomes part of federal law. A 45th state, Michigan, would lose some individual income tax revenue if this provision is enacted. The District of Columbia and New York City, which have local income taxes, also would experience revenue losses.

State revenue estimators and budget planners concur with those estimates. For example, Oregon officials estimate that the bonus depreciation would reduce state revenue by $154 million in the current two-year budget cycle, adding to a $720 million budget shortfall. (The Oregon estimate takes into account any boost to economic activity that might occur as a result of the stimulus package.) Governors across the country and across the political spectrum, including John Engler of Michigan, Bob Taft of Ohio, Parris Glendening of Maryland and Tom Vilsack of Iowa, have expressed strong concern that the $5 billion in lost revenue will make it much harder for states to take part in the economic recovery.

Because they are required to balance their budgets, states must respond to budget shortfalls by cutting spending, raising taxes, or both. Most states have already enacted spending cuts, and several have postponed scheduled tax cuts or raised revenues; further such actions will be necessary in the absence of substantial federal assistance. As Joseph Stiglitz, the 2001 Nobel Prize winner in economics, has noted, "This not only weakens the vital public services that are provided at the state and local levels, but also deepens the economic downturn."

Stiglitz and other economists point out that easing state fiscal crises is one of the very best ways to promote economic recovery. Yet yesterday's Administration proposal fails to offset the $5 billion in lost state revenue with any provision for state fiscal relief. In contrast, the Senate Finance Committee stimulus package provides state fiscal relief in the form of a temporary, one-year increase in the federal matching rate for Medicaid expenditures (FMAP). Such an increase would provide some $5.1 billion in assistance to state budgets this year. The Senate package also includes a smaller bonus depreciation provision that costs states only $2 billion, so the net assistance to states would equal about $3 billion.

If a final stimulus package includes a temporary increase in the federal share of Medicaid costs that provides more revenue to states than they lose from bonus depreciation, then the accelerating decline in state fiscal conditions will be alleviated, states will enact fewer tax increases and spending cuts, and the economy will benefit. But if, as the Administration proposes, the stimulus package simply increases state budget deficits by $5 billion, the economy will suffer.

Estimated Loss of State Tax Revenues in FY 2002
Due to Depreciation Tax Provisions in Administration Proposal
Millions of Dollars
Alabama $56 Louisiana $57 Ohio $200
Alaska 70 Maine 30 Oklahoma 48
Arizona 110 Maryland 120 Oregon 100
Arkansas 53 Massachusetts 270 Pennsylvania 340
California n/a Michigan 60 Rhode Island 19
Colorado 87 Minnesota 180 South Carolina 58
Connecticut 99 Mississippi 55 South Dakota 8
Delaware 31 Missouri 87 Tennessee 110
Florida 210 Montana 22 Texas 340
Georgia 180 Nebraska 33 Utah 43
Hawaii 21 Nevada n/a Vermont 11
Idaho 31 New Hampshire 42 Virginia 140
Illinois 360 New Jersey 260 Washington n/a
Indiana 180 New Mexico 40 West Virginia 36
Iowa 60 New York 710 Wisconsin 140
Kansas 57 North Carolina 190 Wyoming n/a
Kentucky 73 North Dakota 15 States total $5,430
Additional impacts:
New York City 390 District of Columbia 40 States plus