Tax Analysts Blog

Floating on a State Tax Revenue Bubble

Posted on Oct 2, 2013

According to a report issued by the U.S. Census Bureau on September 24, state and local tax revenues for the second quarter of 2013 were up 7.2 percent compared with the second quarter of 2012. A Reuters article reports that this is the “largest intake on records going back to 1988 and the 15th straight quarter of increases.” While all major subcategories of tax showed increases over the last quarter, it is notable that individual income tax revenue hit a record high of $114 billion. That’s an increase of 18.2 percent over the previous year.

It must be good news, right? The economy is recovering and we’re getting back to how things were pre-2008. Well…maybe. According to a report by Lucy Dadayan and Donald Boyd of the Rockefeller Institute, the record income tax receipts are a “temporary ‘bubble.’” The report suggests the recent strong growth in state and local tax receipts is the result of very strong growth in personal income tax collections. And the reason for the very strong growth is that personal income tax returns, which were due on April 15, “appear to have been influenced by taxpayer actions to accelerate income into 2012 to avoid federal tax increases, the strong stock market in 2012, slow but continuing improvement in the current economy and the impact of a large increase in California.”

So despite the strong showing in fiscal 2013, the outlook for 2014 is cautious. The National Association of State Legislatures (NCSL) issued a report projecting that state general fund revenue would grow by only 1.3 percent in fiscal 2014. That is much slower than the 5.5 percent rate we're seeing this year. The NCSL report also predicted that “spending needs are likely to outpace revenue projections as growing Medicaid costs and a protracted economic recovery continue to pressure state budgets.”

None of this should come as a surprise. Experts like those at the Rockefeller Institute have been predicting it for some time. But just because experts can see it coming doesn’t mean legislators will take notice. It will be interesting to see how states ultimately respond to a slowdown in the rate of revenue growth. Given the strong growth in the past several quarters, several states considered, and a few enacted, tax reform plans in 2013 that included reductions in individual income tax rates. Though it is difficult to teach legislators (and voters) to think beyond the present, states may soon regret any tax reform that results in a significant reduction of tax revenue.

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