State revenue growth slows, sparking fear of recession

State revenue growth slows, sparking fear of recession
© National Association of State Budget Officers

State tax revenue growth slowed in the first several months of the new fiscal year, forcing legislators and budget officials in states across the country to slash projections and spending plans while raising concerns that the next economic recession is just around the corner.

A new report from the National Association of State Budget Officers (NASBO) found that half the states have experienced revenue shortfalls in the early months of fiscal year 2017, which began in August. The shortfalls come as sales and personal income tax growth slows and corporate income tax declines.

Those shortfalls forced 19 states to enact mid-year budget cuts in fiscal year 2016 — more than any year outside of a recession since 1990. Some budget analysts fear slowing sales and income tax growth can be a leading indicator that an economic downturn is right around the corner. 

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“A recession is coming sometime soon, but I think economists in all of the state offices would tell you that there’s a really hard economic forecasting angle of predicting when that’s going to happen,” said Michael Cohen, director of California’s Department of Finance.

Cohen said his state, like others, has seen sales taxes consistently miss revenue targets in recent months, spurred by lower consumption.

Lower-than-expected tax revenues are likely to force governors and state legislators of both parties to dramatically alter their plans for legislative sessions set to begin next year.

Oregon Gov. Kate Brown (D) last week laid out plans to cover a $1.7 billion budget hole. Massachusetts Gov. Charlie Baker (R) has ordered nearly $100 million in spending cuts to address a shortfall. An independent agency pegged Pennsylvania’s structural deficit at a whopping $2 billion. Virginia legislators will grapple with a $1.5 billion budget hole.

All told, state general fund spending increased 4.3 percent between fiscal years 2016 and 2017. That rate is below the recent average, though well above 2009 and 2010, the last time the U.S. economy dug out of a recession, when spending fell by 4 percent and 6 percent, respectively.

“Many states have not yet achieved full recovery from the Great Recession, on an inflation-adjusted basis,” said John Hicks, NASBO’s executive director.

States expect to bring in a total of $808 billion in revenue, up 3.6 percent over the year before. But 12 states — Alaska, Delaware, Illinois, Indiana, Louisiana, Montana, New Mexico, North Dakota, Oklahoma, Texas, West Virginia and Wyoming — experienced revenue declines in 2016, and eight more expect revenues to drop this year. 

“We’re approaching probably the latter stages of a recovery cycle,” said Jim McIntire (D), Washington State’s treasurer and president of the National Association of State Treasurers. “You get people slowing down their spending a little bit if they’re not feeling a wealth effect. You’re going to see some slowdown in retail sales and tax growth.” 

States were forced to cut a total of $2.8 billion out of their budgets in the last fiscal year, and more states are likely to face cash flow crunches in upcoming legislative sessions. Seventeen states implemented cuts to their K-12 education programs, and eleven states cut public assistance programs. 

Energy-producing states like Alaska, Louisiana, New Mexico, North Dakota, Oklahoma and Wyoming were particularly hard-hit, as falling global commodity prices caused extraction tax revenues to tumble. Among the 12 states that saw revenues decline in 2016, nine are major energy producers.

Wyoming’s spending declined more than 20 percent between 2016 and 2017 as oil and coal prices fell. Spending in Alaska — which relies on taxes generated by its oil industry for a huge percentage of its overall revenue — dropped almost 10 percent, while the state hiked fees and laid off employees. Louisiana cut almost $350 million from its budget. 

Few states have moved to increase taxes on a broad swath of the population, largely out of political considerations. Instead, states have passed hikes on cigarettes, which generates less revenue as the smoking rate declines.

“States are extremely reluctant to raise broad-based taxes, the income tax and the sales tax. That’s where the money is,” said Don Boyd, director of fiscal studies at the Rockefeller Institute of Government.

Some state budget officers are concerned that full Republican control of Congress and the White House, beginning in 2017, will mean further budget reductions in future years. Congressional leaders and President-elect Donald TrumpDonald TrumpUS, South Korea can bury the trade barrier hatchet this week OPINION: Trump's right — GOP health bill is mean, mean, mean Pelosi on criticism of leadership: 'This is such a small item, it isn't about me' MORE have promised tax cuts, and those cuts could spur wealthy individuals and corporations to take advantage of write-offs now, when they are more valuable, than in the future.

States are watching GOP proposals to repeal and replace the Affordable Care Act, which steers billions of dollars in Medicaid spending to state coffers. Any replacement would likely reduce those contributions, placing further strain on state budgets that are required to fund the federal program. 

“Legislators need to be cognizant of ongoing responsibilities and avoid over-committing so they don’t end up having to cut back dramatically should we run into a downturn,” McIntire said. “This is a time to be cautious.” 

After the Great Recession decimated state budgets across the country, states have increasingly turned to rainy day funds to sock away cash in advance of the next downturn. Rainy day fund balances grew in 29 states over the last fiscal year, the NASBO report found, and 25 states anticipate increasing their rainy day funds this year as well. 

Still, if a recession is around the corner, even those states that planned ahead are likely to feel the pinch. 

“States recognize that a reserve fund is only one piece of a set of actions that take place during revenue shortfalls,” Hicks said. Boyd said rainy day funds “can never be large enough to get you through even a moderate recession.”