State tax collections lagging behind overall growth in economy

Eight years have now passed since the Great Recession rocked state finances, and since that time, state policymakers have had to settle for a modest recovery and still deal with a difficult fiscal environment. In a July presentation to state legislators, John Hicks, executive director of the National Association of State Budget Officers, detailed just how different — and more challenging — this period has been compared to other post-recession eras.
Since 2011, year-to-year revenue growth in the states has never reached the historic annual average of 5.5 percent, and for fiscal year 2018, the nation’s governors were recommending an increase of only 1.0 percent (and just 0.17 percent in the 11-state Midwest).
“That’s a notable item eight years into a recovery, and it isn’t because we’re cutting taxes and having to balance our budget as a result,” Hicks said during his presentation at the Midwestern Legislative Conference Annual Meeting’s Fiscal Leaders Roundtable. Instead, this slow rise in state spending reflects a “new normal” in tax collections, the result of only moderate increases in gross domestic product and, on top of that, a gap between changes in U.S. gross domestic product and the taxes being collected by states.

“[States’] revenue streams are growing less than the economy, at least half to a full percentage point off of GDP,” Hicks said. “That didn’t used to happen.”

Why is the discrepancy occurring now?
The answer likely lies somewhere in states’ collections of personal income and sales taxes, which account for 77 percent of general fund revenue. Potential causes include a decline in the price of tangible goods (thus driving down sales tax revenue), the failure or inability of states to collect taxes from services and Internet sales (both are growing parts of the U.S. economy), and a decision by many taxpayers to delay sales of their stocks in anticipation of possible changes in federal law that would cut the capital gains tax.
In fiscal year 2017, all 11 Midwestern states (and 35 nationally) had to revise their economic forecasts downward and adjust their budgets accordingly. To the extent that states can spend more, Hicks told lawmakers, that money is disproportionately going to two areas: K-12 education and Medicaid.
“[State agencies] continue to get the dregs or continue to be cut,” he said. “They haven’t recovered from the Great Recession and they won’t. This is permanent.”
Similarly, a smaller portion of state general funds is going to higher education — 9.7 percent in FY 2016 vs. 11.3 percent in FY 2008. Over that same time, Medicaid spending has jumped from 16 percent to 20 percent.
Along with health care and K-12 schools, public pension systems are another big cost driver crowding out other areas of state budgets.
“We as a group of states have reformed our pension plans or created new ones, particularly for new employees — for example, hybrid cash balances, defined contributions, moving away solely from defined benefit, changing the amount of time it takes to get a full pension,” Hicks said. “But those changes don’t have a lot of an immediate effect on our pension liabilities. … We are getting out the checkbook [to pay for those liabilities].”
Stateline Midwest: August 20172.46 MB