Report: States Face Long-Term Budget Gaps

States’ failure to modernize their tax systems to reflect the shift from a manufacturing to a service-based economy puts many at risk for chronic budget gaps, according to a May 17 report from the Center on Budget and Policy Priorities, a Washington, D.C., think tank that focuses on policies that affect the poor.

Unless states alter their basic tax structures, they will face the hard choice each year of raising taxes or cutting government services, said Robert Zahradnik, a senior policy analyst at the Center and co-author of the report.

The report said Alaska, Arkansas, Colorado, Florida, Nevada, New Mexico, Pennsylvania, South Carolina, Tennessee, Texas, and Wyoming face the greatest risk of a “structural deficit,” which the Center defines as a chronic inability to grow state revenues in tandem with growth in state government expenses or the state’s economy.

The states rated as best-positioned financially are Minnesota, Nebraska, New Jersey, North Dakota, Vermont and Wisconsin, where expenditures are reportedly least likely to annually outpace revenues

The report, titled “Faulty Foundations: State Structural Budget Problems and How to Fix Them,” includes a state-by-state analysis of the factors that put each state at risk for a structural deficit.

Most states’ failure to tax services, coupled with the rapid growth in Internet purchases – the vast majority of which escape state sales tax – are a prime cause of states’ inability to keep pace with growing expenses, according to the report.

Other factors include shrinking corporate income tax revenue, antiquated personal income tax brackets, federal restrictions on state taxing authority and state-imposed tax and spend limits.

The report highlights states’ responses to factors that put them at risk for a structural deficit, such as Virginia’s recent decision to phase out income-tax exemptions for pension incomes and Nebraska’s effort to expand its sales tax base to include services.

It concludes that serious budget problems loom even though states’ revenues are on the upswing as the nationwide economy recovers from the 2001 recession.

“With the fiscal crisis easing in most states, states can take the initiative to modernize and strengthen their revenue systems,” Liz McNichol, a senior fellow at the center and a co-author of the report stated in a press release.

Zahradnik cited an April 14 study by the National Conference of State Legislatures in which budget directors in about half of the states reported concerns that a structural budget gap is developing.

The Center’s report stresses that states’ current and upcoming structural budget problems are largely independent of cyclical budget shortfalls due to economic downturns.

States will find it next to impossible to claw their way out of structural deficits unless they expand their tax base and halt recent efforts in many states to cut taxes, Zahradnik said.

On the other hand, Paul Prososki, state government affairs manager for the anti-tax group Americans for Tax Reform, challenged the report’s conclusion that state revenues need to be expanded to meet state governments’ needs.

“There is not a revenue problem here,” Prososki said. “It’s just that after three years of not being able to grow government because of the recession, they want to make up for it by growing government amazing quickly.”

Raising taxes won’t solve states’ structural budget problems because costs to states of programs such as Medicaid are growing so quickly that they will continue to outpace revenue growth, even with modest annual tax increases, he said. Prososki added the states should instead search for innovative ways to reduce the costs of those programs without decreasing the quality of services.

“We can’t fix it on the tax side,” he said. “We have to fix it on the spending side.”