State Tax Collections Up, So Where's the Money?

Feb. 8, 2006 — -- Census Bureau data shows a sharp increase in state tax collections, which has some observers asking, Where's the money?

Tax experts were not surprised by Census Bureau data that showed U.S. state taxpayer burdens climbed 41 percent between 1994 and 2004, due in part to rising education and Medicaid costs.

The census data numbers do not include federal or local taxes, which in many states account for a large portion of tax collection.

The economic downturn after 9/11 played some part in boosting state tax levels, as did the tax cuts enacted by President Bush in 2001 and 2002.

Tax collections fell sharply in 2002 and continued a downward trend in 2003. States took a variety of steps to raise their revenues, including some tax increases.

"When budget times are tight, like they were in 2001 after 9/11 and after the economic downturn, states will raise taxes," said John Berthoud, president of the National Taxpayers Union, a nonprofit group that supports lower taxes.

Some states "uncoupled" their taxes from the federal tax system after the Bush tax cuts, meaning that individual state taxes, which were in part previously determined as a percentage of the amount of federal taxes owed, moved to a more independent system. Some states also made minor changes, like instituting state estate taxes and putting state regulations on the rates at which businesses could depreciate the value of their equipment.

Historically, Not a Huge Tax Raise

A smattering of tax increases resulted in a 1.7 percent to 1.9 percent increase in state taxes nationwide in 2003 and 2004, according to statistics compiled by the National Conference of State Legislatures. That is a much smaller boost than was seen after the most recent recession in 1991, when NCSL data showed a 5.4 percent year-over-year tax increase.

But even though the increases were small by historical standards, the ramp-up after the 2001 recession, coupled with a quicker-than-expected economic recovery, has bolstered coffers in some states.

"Any tax increases that did pass after the remarkably low collection in 2002 are contributing to the increased collections now," said Bill Ahern, of the Washington-based Tax Foundation, a watchdog group that has monitored tax policy since 1937.

The shortfall in state funds after the recession that began in 2001 was not made up only through tax increases. The NCSL estimated that states operated under a cumulative $263.7 billion budget gap during the past five fiscal years. In addition to small tax increases, many states cut funding to projects and tapped reserve rainy day funds to meet budget obligations.

As the economy built strength and tax collections increased, some states now contemplate what to do now that financial footing has improved.

Most states try to have an amount equal to 3 percent to 5 percent of yearly revenues set aside in reserve funding in case of a recession or a disaster that might require immediate funding. For some, the recent influx of money may first go toward replenishing the reserve funds that were tapped after the 2001 recession.

"That's the question that's being asked in state capitals: Do they rebuild the reserve fund, the rainy day fund? Do they increase the funding that was cut before?" said Arturo Perez, fiscal analyst at the NCSL. "A lot of state programs are still operating on far less fiscal support than they did in 2001."

Tax Reductions Also Possible

Some tax organizations also expect a rollback of previous tax increases in states that now have budget surpluses.

"For states that have raised taxes, it's time to return some of those tax levels to where they were before," said Berthoud, of the National Taxpayers Union.

Connecticut, Kansas and Hawaii are among the states that have seen surpluses. With the midterm elections coming up next fall, state tax cuts are likely to be a rallying point in election campaigns. Tax issues have already come into play amid early campaign talk in Nebraska, Rhode Island and New York.

"A lot of states enacted new tax increases after the recessionary period, and the taxes overall have gone up," said Chris Atkins, of the Tax Foundation. "But now surpluses are coming, and a lot of states are looking at reinvesting those surpluses into their tax systems."

But the NCSL's Perez noted that because of the sharp drop in tax collections after the federal tax cuts and the Wall Street collapse of 2001, year-over-year increases may not indicate a return to prerecession budget stability. For many states, until they can replenish their reserve funds and renew program funding that was cut over the past several years, surpluses may be hard to come by.

"The changes in collections might appear to be greater than they actually are," he said. "Some states would say we're just now back, in terms of collections, to where we were before 2001."