FOR IMMEDIATE RELEASE:
Monday, May 22, 2000
CONTACT: Bob Zahradnik, Iris Lav,
Jim Jaffe, Michelle Bazie
STATES INCREASINGLY UNPREPARED FOR RECESSION,
NEW FISCAL STUDY WARNS
Five of the eight states that last year had adequate budget reserves to weather a recession have since enacted tax cuts that erase this margin, according to a new study from the Center on Budget and Policy Priorities.
The report, When It Rains It Pours One Year Later, is an update of a Center analysis issued in March 1999. The 1999 report, When It Rains It Pours: A Look at the Adequacy of State Rainy Day Funds, found that only eight of the 48 contiguous states had adequate reserves to maintain services in a recession without increasing taxes.
In the new study, Center policy analyst Bob Zahradnik and Center deputy director Iris J. Lav, explain why five of the eight states that had adequate reserves in 1999 Delaware, Indiana, Massachusetts, Michigan, and Minnesota are not likely to be able to afford to maintain current spending levels in a future recession similar in depth and duration to the recession of the early 1990s.
Massachusetts faces the most dramatic change. In the March 1999 report, Massachusetts was found to have reserves approximately equal to the amount necessary to weather the projected recession without raising taxes or substantially cutting spending.
- As a result of the tax cuts enacted in 1999, Massachusetts would face a relatively modest shortfall of 2.7 percent of spending in the projected three-year recession.
- If Massachusetts enacts the income tax rate reduction and other tax cuts currently being debated, however, the state's projected shortfall would increase dramatically from $540 million to $4.8 billion, an amount equal to 24.4 percent of general fund expenditures.
Enactment of large, phased-in tax cuts in two successive years converted Michigan's projected cushion of 8.0 percent of spending to a projected shortfall of 10.4 percent of expenditures in the hypothetical next recession. Michigan is phasing in a reduction of its personal income tax rate from 4.4 to 3.9 percent by FY 2004, and has enacted a gradual, complete phase-out of its major business tax. The annual cost of these tax cuts is projected to grow to $1.9 billion by FY2004.
In Indiana and Minnesota the budget reserves and rainy day funds anticipated at the end of fiscal year 2000 are short of the reserves necessary to continue current programs without raising taxes during a recession by 8.0 percent and 9.0 percent of annual general fund expenditures, respectively. In Delaware, the projected shortfall is equivalent to four percent of annual general fund expenditures.
The analysis projects the gaps between revenues and expenditures states could face in the next recession by assuming each state maintains its historical expenditure pattern while experiencing a decline in revenue growth similar to the average revenue declines in the last recession. It translates these gaps to the amount of reserve funds each state would need to have on hand at the onset of the recession to weather the downturn without raising taxes, substantially reducing spending, or engaging in fiscal gimmickry such as shifting costs to other levels of government, and compares needed reserves to available reserves.
"The intent of the report is not to say that each state must have the full amount of needed reserves on hand at all times," according to Center Deputy Director Iris Lav, "but rather to inform the process of thinking about reserves so states can avoid yo-yo budgeting tax increases and budget cuts during recession followed by tax cuts during recovery that in the past has skewed budget priorities, interfered with efficient delivery of services, and deprived residents of needed services."
The results for the three other states detailed in the report include the following:
- In Delaware, a large income tax cut, coupled with several other smaller tax reductions has reduced the state's ability to weather a recession. Delaware went from having reserves that were 3.1 percent of spending more than would be needed in a recession to a projected shortfall equal to 4.1 percent of general fund expenditures.
- Indiana cut personal income taxes, enacted property tax relief and increased spending. The tax cuts have reduced annual revenues below annual expenditure levels, and the state has been using accumulated reserves to fund annual appropriations. Indiana's reserves are projected to be fall short by 8.0 percent of spending $766 million of the amount needed to maintain services during the projected recession.
- Minnesota enacted $2 billion in tax cuts in 1999 and, early this year, approved a sales tax rebate that will result in a one-time $650 million revenue loss. Additional tax cuts become effective next year. As a result, the projected shortfall between Minnesota's reserves and what would be required to maintain services during a future recession is 9.0 percent.
The report concludes that most states are enjoying extraordinary fiscal health and strong revenue growth while budgeting relatively conservatively. The result has been the accumulation of growing fund balances. "Many states view these good economic times as an opportunity to enact large tax cuts," notes Center analyst Bob Zahradnik. "But the good times may not continue indefinitely and the severe service reductions and tax increases required during the last recession could return if states are not better prepared than they were in the early 1990s."
This report was issued by the State Fiscal Project of the Center on Budget and Policy Priorities, a national nonpartisan research organization and policy institute that conducts research and analysis on a range of government policies and programs, with an emphasis on those affecting low- and moderate-income households. The State Fiscal Project, which was founded in 1992, prepares analyses and provides technical assistance on state tax and budget issues. The Center on Budget and Policy Priorities is supported primarily by foundation grants.
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