Sprouting Springtime Revenue

By: - May 6, 2010 12:00 am

After two years of plummeting revenues, state governments are slowly starting a long climb back this spring as tax collections exceed estimates in several states.

With two months left in the current fiscal year for most states, the improvement in revenue comes too late to forestall a third straight year of cutting spending and raising taxes and fees. States face two or more years of gradual recovery because tax collections plunged more than 18 percent during the recession.

Still, state officials are more optimistic today about the direction of the economy than they have been since the recession began in December, 2007. That’s true even though California got some bad news this week: After several successive months of revenue growth, tax collections there took a dive in April.

Many states aren’t experiencing California’s disappointment. “Based on the revenue trends we’re seeing now, Oklahoma’s economy is on the mend,” says Treasurer Scott Meacham. The state’s tax collection forecasts for February exceeded figures from the same month the previous year for the first time since December 2008.

The upturn in tax revenues in the first three months of the year reflects the growth in economic activity nationally since the recovery began last fall, analysts say. “It feels like a light switch is going on,” says Mark Zandi, chief economist at Moody’s Economy.com. “Things are turning around. But while revenues are starting to rise, the budget holes are deep.”

Nine states reported year-over-year increases in revenue between September and December, according to the Nelson A. Rockefeller Institute of Government. In recent weeks, several other states such as Oklahoma that had been overestimating their monthly revenue projections now are ahead of last year or are predicting increases in the fiscal year that starts July 1.

Higher than expected oil prices will pump an extra $900 million into Alaska’s budget this year and next. Tourists are trickling back to Hawaii after two years of decline, boosting hotel room tax collections. Illinois economists say tax receipts will increase in the coming fiscal year for the first time in almost three years. Economists in Michigan are predicting that the state with the nation’s highest unemployment rate will see growth in jobs and economic activity for the first time in five years. “We have hit bottom,” Michigan Gov. Jennifer Granholm   declared on CNN recently.

Even in Arizona, where year-over-year revenues have fallen for 17 straight months, officials celebrated single-digit percentage declines in revenue instead of double-digit drops. “It will be several months before it feels like things are getting better, and it will take years to repair all the damage that’s been done,” says Marshall Vest, a University of Arizona economist. “But the business cycle has turned up once again — and that’s the best news we’ve had for a long time.”

The revenue rebound had been expected once the recession ended in September and activity picked up in the manufacturing, retail, real estate, energy, construction and financial services sectors.  “I thought it would have happened before now,” says Scott Pattison, executive director of the National Association of State Budget Officers.

But Pattison and others are hardly giddy about the flash of good news. He notes that Michigan’s revenue picture may be getting better, but the state’s general fund this year is smaller than it was in 1997. The same is true in other states, where population has grown compared to a decade ago and the costs of state government, such as Medicaid, corrections, education and pensions, have shot up.

California seemed until this week to be going in a positive direction: A tax revenue increase in March marked the fourth straight month that the state exceeded Gov. Arnold Schwarzenegger’s budget estimates. But then tax collections fell 30 percent in April. California Controller John Chiang says high unemployment and lower-than-usual income tax revenue “tells us the road to recovery will be long and arduous.”

California’s 30-percent drop in April tax collections was fueled largely by personal income taxes that fell below projections. In a report issued Tuesday (May 4), the Rockefeller Institute said a decline in personal income tax revenues collected by the federal government in April could foreshadow similar drops in state tax collections compared to 2009. If that happens, “some states will find that they face new shortfalls,” says Rockefeller senior fellow Donald J. Boyd.

California isn’t the only state that seems to be missing out on the modest revenue recovery. A steady drop in tax collections is forcing Kansas lawmakers to consider a sales tax increase to avoid slashing aid to public education. Montana lawmakers were told last week that the fall in tax revenue would require a 10 percent budget cut. Arkansas officials on Tuesday (May 4) announced a decline in revenue in April that will have to be made up from rainy day funds.

Many states are like New Jersey, where revenues were up slightly in March but it will not make much difference in the state’s budget shortfall because tax collections are hundreds of millions of dollars behind for the first nine months of the fiscal year that began July 1.

States are nowhere near back to normal economic activity. Montana’s energy-based economy usually grows 3.3 percent per year but will only expand 1.3 percent this year, economists say. Despite the addition of jobs in states such as Ohio, Georgia and Minnesota, unemployment remains high, which slows income and sales tax revenue and increases state spending on Medicaid and other social programs.

The next two years won’t be great for states, analysts say, but they will be better than the last two. Jim Muschinske, revenue manager for Illinois’ economic forecasting commission, says fiscal 2011 will be a “transitional year” between recession and recovery. Revenues will improve compared to the past two years, he says, but will not grow significantly until 2012.

Analysts stress that a huge source of revenue used to prop up states the last two years — the federal economic stimulus package — is drying up. They also say housing sales have increased in states such as Oregon and Utah compared to a year ago because of the first-time homebuyer tax credit, part of the stimulus package. What happens to revenues after that program wraps up remains to be seen.

Even when states recover from the recession, they may never return to the boom times of the late 1990s. The new federal health care program could escalate Medicaid costs, for one thing. States also face years of catching up on public pension contributions, even though many have enacted reforms. “The single biggest threat to the fiscal health and to California’s future, obviously, is our public pension system,” says Schwarzenegger.

Still, despite the many exceptions and caveats, the rise in revenues is part of a pattern of hopeful economic news after three years of gloom and doom. In Iowa, the three major financial rating agencies recently gave the state the highest possible rating — AAA — which the state treasurer interpreted as proof the economy was improving. Farmers in Iowa have planted more corn this spring than at any time in the state’s history, which could be good news for tax collections, assuming commodity prices remain high.

For the positive news to continue, consumers may hold the key.  Edward H. Boss, Jr., chief economist of the Illinois government forecasting commission,   says consumer spending generally accounts for about two-thirds of total spending in the U.S. “Without stronger consumer spending,” he says, “the economy will likely show only modest growth in the quarters ahead, which is unlikely to be strong enough to create enough jobs to significantly reduce the unemployment rate.”

In Oklahoma, Treasurer Meacham has been urging citizens to spend their money. “The message to consumers is: The economy is improving so it’s time to go back and start buying again. We are adding jobs to the economy so people who have jobs are not at risk like they were six or 12 months ago. People don’t have to be as cautious or pessimistic about the future as they were.” 

Our stories may be republished online or in print under Creative Commons license CC BY-NC-ND 4.0. We ask that you edit only for style or to shorten, provide proper attribution and link to our web site. Please see our republishing guidelines for use of photos and graphics.

Stephen Fehr

Stephen Fehr is a senior officer with Pew’s government performance portfolio. He is a lead writer on many of the products generated by the portfolio, specializing in state and local fiscal health.