Washington, DC 20002
Iris J. Lav
Board of Directors
David de Ferranti, Chair
John R. Kramer, Vice Chair
Henry J. Aaron
Barbara B. Blum
Marian Wright Edelman
James O. Gibson
Beatrix Hamburg, M.D.
Richard P. Nathan
Robert D. Reischauer
Juan Sepulveda, Jr.
William Julius Wilson
MANY STATES FACE STRUCTURAL
“After we came out of the 1990s recession, states generally lost interest in fixing their structural problems because the bubble revenues of the late 1990s masked the problems — but the problems now have reemerged,” said Liz McNichol, senior fellow at the Center and author of the report. “With the fiscal crisis easing in most states, states can take the initiative to modernize and strengthen their revenue systems.”
The new report, Faulty Foundations: State Structural Budget Problems and How to Fix Them, is the first to provide state-by-state measures of the policies that put a state at risk of a structural deficit. It includes fact sheets with the findings for each state.
The report finds that the states most at risk of structural deficits are Alaska, Arkansas, Colorado, Florida, Nevada, New Mexico, Pennsylvania, South Carolina, Tennessee, Texas and Wyoming. These states scored nine or higher on the structural deficit risk scale developed in the report. More than half of the states scored seven or higher, and no state had fewer than three risk factors.
Obsolete Revenue Systems in Many States
A prime cause of structural deficits is that most states have failed to respond to the economy’s shift from goods to services, which make up a growing share of all economic activity. That shift has cut into state sales tax revenues, since most states do not tax services. The rapid growth in Internet purchases is also hurting sales tax revenues, since states generally cannot collect taxes on these purchases.
State income taxes have weakened in recent decades as well. Corporate income tax revenues have shrunk by nearly half as a share of total state revenues over the past two decades, as a result of obsolete state corporate tax policies and corporations’ increasingly aggressive tax-avoidance schemes.
Many states’ personal income tax systems have become “flatter” as a growing share of taxpayers have moved into the top tax bracket (usually because the state failed to update its brackets to reflect rising incomes). In 18 states plus the District of Columbia, households with taxable income of $30,000 are in the same bracket as those with taxable income of $300,000. In addition, the extra tax breaks many states give to the elderly — regardless of income — are becoming increasingly costly as the population ages.
Other important causes of state structural deficits include federal restrictions on state taxing authority (such as the federal ban on state taxation of Internet access fees) and state budget requirements that limit revenues (such as tax and expenditure limits).
Comparing States’ Risk Of Structural Deficits
Inadequate Funds to Maintain Current Services
In states with structural deficits, revenues do not grow at the same rate as the cost of government. As a result, these states are unable to continue providing their current level of services, let alone respond to voters’ demands for new investments in education and other areas.
Structural deficits have received little public attention to date, largely because states have adopted various ad-hoc measures to mask them. For example, many states raised sales taxes: the average sales tax rate rose by about 50 percent between 1970 and 2003. Sales tax revenues, on the other hand, rose by only 20 percent during this period because of the shrinkage of the sales tax base. Raising tax rates is not a permanent substitute for fixing underlying problems because it places unfair burdens on a narrow segment of the population and undermines public confidence in government.
Some States Strengthening Their Fiscal Foundation
The report evaluates each state’s susceptibility to structural deficits by determining how many risk factors apply to the state. The report considers ten risk factors, including the extent to which the state taxes services, the strength of the corporate income tax, the progressivity of the personal income tax, and the presence of revenue barriers such as tax and spending limits.
The report also outlines policy responses to each of these risk factors, some of which have already been adopted by certain states:
“States are playing a greater role than ever before in providing public safety, health care, and education.” said Iris Lav, deputy director of the Center and co-author of the report. “Modernizing their fiscal systems by identifying and fixing structural problems will prepare them to shoulder these responsibilities.”
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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.