The States' Reaction to the Economic Climate: A Comparative Analysis

By Honey, Jean | Business Perspectives, Spring 2002 | Go to article overview

The States' Reaction to the Economic Climate: A Comparative Analysis


Honey, Jean, Business Perspectives


Fiscal year 2000 signaled the peak of a record economic expansion. At the close of that fiscal year (June 2000), states reported a collective year-end balance of 10.4 percent, (1) the highest in 20 years. During 2000, state revenues grew by 8.0 percent, and 30 states began 2001 with reported surpluses of 5.0 percent. (2) Forty-two states responded to the climate of prosperity by lowering taxes, thus generating a total reduction of $5.2 billion.

However, the euphoria of 2000 was followed by a sobering 2001. During fiscal year 2001, there was a precipitous decline in revenue growth. Revenues increased by a modest 4.5 percent--the slowest growth experienced since 1993--in nominal terms. (3) The real increase, adjusted for inflation, amounts to just over 2.0 percent. As one result of the current recession, which has been accompanied by a 14.0 percent rise in the cost of health care and increasing unemployment rolls, 17 states were experiencing budget shortfalls even before the September 11 attacks. Since this national disaster, 44 states have faced lower-than-expected revenues, (4) 19 have exceeded their budgets, and 36 have reported shortfalls. (5) These budgetary crises were fueled partially by states' needs to augment their security systems in the wake of September 11. According to a report issued by the National Association of Governors, the projected total shortfall for 2002 is $25 billion. (6)

Collectively, states spend nearly $1 trillion per year--the equivalent of roughly half the amount spent by the federal government. (7) The tax burdens imposed for 2001, as well as the primary sources of revenue for each state, are summarized in Table 1. As evidenced in this table, there is a wide variation in the mix of taxes adopted by respective states. Nine states--Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming-have little or no personal income tax. Of these, Tennessee and New Hampshire impose de minimus taxes on interest or dividends. Conversely, Massachusetts and New York depend on income tax for more than 50.0 percent of their total revenues. Five states (Alaska, Delaware, Montana, New Hampshire, and Oregon) have no sales tax; by contrast, Florida, Nevada, Tennessee, and Washington rely on sales tax for more than 50.0 percent of tax revenues. Alaska depends heavily on oil-severance-related taxes and royalties, much as New Hampshire relies on its property taxes and business tax. Similarly, Wyoming depends on severance taxes, and Delaware obtains one-third of its revenues from state licenses. (8)

Before the September 11 attacks, the industrial states were more sensitive to the economic downturn than were more service-oriented economies. However, the national disaster sent economic shockwaves throughout the economy. The only states whose economies have proved more insulated against the economic recession have been energy-rich states such as Alaska, Oklahoma, and New Mexico, which benefited from the increases in oil and natural gas prices. Revenues for these states increased by more than 10.0 percent collectively.

Although nine states managed to cut taxes during fiscal year 2001, others struggled to balance their budgets. Sixteen cut their budgets, six increased taxes (Michigan and Minnesota each increased theirs more than 5.0 percent), and nearly all had to draw on their reserves.

Other states have tried to adopt strategies for raising revenues without increasing taxes. For example, North Carolina tried to stimulate new business operations with a bill that includes a major corporate income tax credit for companies initiating large-scale projects in less-developed countries. Ohio customized a tax incentive package with the intention of encouraging Korea-based Hyundai to establish an operation in the state. (9) Alaska, seeking a way to temporarily increase tax revenues without burdening state residents, decided upon a 6. …

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