Tax Analysts Blog

Break Out the Champagne

Posted on Jul 17, 2013

In the past two weeks, the Tax Foundation has released two maps that provide detail on states’ rainy day funds. The first, released on July 8, showed rainy day fund balances as of 2007, before the economy began its downturn. The foundation calculated each state’s rainy day fund as a percentage of annual general fund spending. The second, released on July 15, showed the same data from 2013.

The 2013 map showed that several states have increased the amount of their rainy day funds from what they were in 2007. This is positive news. However, only Alaska, Wyoming, West Virginia, and Texas had rainy day funds that exceeded 18 percent of their annual general fund spending amounts. (A report issued in 2008 by the National Conference of State Legislatures suggested that “the typical state can expect a revenue shortfall equal to 13 to 18 percent of revenue during a normal downturn.”) Seven states have no rainy day fund at all, while an additional five states have less than one percent in a rainy day fund.

We are now five years from the Great Recession of 2008 and state revenues are up. Some states, including California, are reporting surpluses. If revenues are up so significantly, why are some rainy day funds still feeling the weight of the recession?

The National Association of State Budget Officers reported in their Spring 2013 Fiscal Survey of States that the fiscal distress felt by states during the recession is subsiding. That implies, of course, that the fiscal distress is not entirely gone. And two of the biggest long-term budgetary concerns for states are Medicaid costs and unfunded or underfunded state retirement programs. A report put out by the State Budget Crisis Task Force in 2012 indicated that, using actuaries’ current assumptions to value liabilities, state and local government pensions were underfunded by approximately $1 trillion.

So while the economic picture for states is certainly better than it was several years ago, states should refrain from breaking out the champagne. But, of course, they haven’t heeded that advice. California Gov. Jerry Brown is reveling in the budget he just signed, which was up almost $10 billion from two years ago. In North Dakota, a budget was approved, which more than doubled spending for the next two years. And in Texas, a biennial budget was approved which increased spending to $106 billion from $84 billion.

The sudden spending is largely fueled by a sudden increase in tax revenue. The Rockefeller Institute reported that the first quarter of 2013 showed continued growth in state tax collections, “mostly driven by very strong growth in personal income tax collections.” In fact, state personal income tax collections increased by 17.6 percent over last year.

Unfortunately, this increase isn’t the result of people suddenly making a lot more money. It is because individuals and companies accelerated income at the end of 2012 by cashing in nearly $500 billion of capital gains, dividends and other income to avoid the impending federal tax increase.

The Rockefeller Institute report provided a second caveat for the increase in personal income taxes: California. California saw a 52.2 percent increase in income tax collections in the first quarter of 2013. The growth reflects both acceleration as well as recent income tax rate increases that were only partially reflected in withholding. The report indicated that “If California were excluded, income tax collections in the remainder of the nation would show growth of 9 percent in the first quarter of 2013.”

The picture is certainly not as grim as it was a few years ago, but states should slow down and think before they go on spending sprees. There are looming debts that need to be paid and rainy day funds that need to be replenished. Given that the tax collections states are seeing now may not be permanent, increases in spending now could bring a rainy day in to the forecast much sooner than expected.

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