States face fiscal challenges as Congress weighs tax reform

by Reid Wilson - 09/19/17 11:31 AM ET

State governments are likely to face a new round of budget cuts and belt-tightening as revenue growth slows, due in part to uncertainty over whether Congress will reform the federal tax code.

A new report from the Rockefeller Institute of Government found state and local government tax collections increased by 4.2 percent in the first quarter of 2017, over the same period last year.

On its face, that growth is strong, and stronger than the 1.9 percent growth that state and local governments experienced over the previous four quarters.

But the institute’s researchers warned that much of the increase was attributable to rising personal income tax gains in just two states — New York and California — and that preliminary data from later this year shows a falloff in revenue gains.

{mosads}Many taxpayers delayed taking bonuses or sped up claiming deductions in 2016, anticipating action from Congress this year. But Congress has not yet acted to reform the tax code, meaning taxpayers are paying the same rates they would have last year.

“Overall, states are facing fiscal challenges, partially because of uncertainty surrounding federal tax reform,” said Lucy Dadayan, lead author of the Rockefeller Institute’s report.

The preliminary figures for the second quarter of the year, when most Americans pay their taxes, hint at trouble ahead, the report says. Potential cuts in federal aid to state governments also adds to anxiety over the future of state fiscal health.

Tax collections fell in twelve states in the first quarter of the year, compared to the same period last year. Mississippi, Wyoming, South Carolina and Michigan experienced the steepest declines, of more than 6 percentage points each.

Ten states saw significantly higher tax collections, led by Alaska, where rebounding oil prices more than doubled revenue generated by the state’s extraction tax. Washington, Oregon, Montana, Utah, Minnesota, Iowa, Missouri, Louisiana and Ohio all saw significantly more tax revenue than they did last year.

Corporate income tax payments have plummeted since the worst of the recession. The total amount corporations have paid in state income taxes has fallen for six consecutive quarters — though preliminary data suggests corporate tax payments will rise substantially through this year as companies pay taxes on income they delayed last year, in anticipation of federal reform.

Dadayan said the damage from Hurricanes Harvey and Irma is likely to substantially harm the fiscal standings of Texas and Florida in years to come. While the extent of the damage is still being assessed on the ground, both states are likely to face billions of dollars in cleanup and recovery costs, at least some of which will come out of state budgets even after federal aid packages are factored in. Dadayan pointed to Louisiana, which is still struggling with the fiscal aftereffects of Hurricane Katrina, a dozen years after the storm made landfall.

Even temporary disruption in the labor market can harm a state’s fiscal standing.

“We will see large declines in the coming months or quarters in income taxes and sales taxes and property taxes,” Dadayan said. “It’s going to take years for them to recover from the damage from the hurricanes.”

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