Balancing State Budgets: Who Will Pay?

How can states solve their fiscal dilemmas? By shifting the tax burden onto the well-to-do.

Chuck Collins

This article is from the March/April 2002 issue of Dollars and Sense: The Magazine of Economic Justice available at

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This article is from the March/April 2002 issue of Dollars & Sense magazine.

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In this time of war and recession, state budgets across the country are plunging into a sea of red ink. Who will be making the greatest sacrifice? Many state legislatures have already begun to answer that question, by reflexively cutting health, education, and other social programs aimed at those in need.

But the burden doesn't have to fall on low-income people. With the tax season approaching, the alternative is obvious: increase revenue by shifting the tax burden to those who can afford to pay.

In a dizzying turnabout from the flush years of the late 1990s, at least 43 states are anticipating that their 2002 revenues will fall below what they budgeted, according to the National Conference of State Legislatures. The National Governors Association is forecasting state deficits totaling $50 billion and rising. The California legislature is staring down a $12 billion revenue shortfall, and New York, Washington, and Massachusetts contemplate deficits of over $2 billion each in the next two years.

While the immediate cause of the fiscal distress is the drop in revenue resulting from the recession, there are other contributing factors as well. Between 1993 and 1999, states cut taxes by $35 billion, in part because of sustained organizing by anti-tax and limited-government groups and politicians eager to cut taxes. Along with implementing a wide range of cuts in income and sales taxes, politicians offered generous tax incentives and subsidies to corporations.

But even before the recession—and even before the notorious Bush tax cut—state budgets were already in trouble, facing structural deficits (deficits not tied to economic conditions) that were masked by the late 1990s revenue boom. For example, states have been losing sales tax revenue for the last ten years. On average, states depend on sales taxes for about 40% of their revenue. But in the past decade, internet sales have skyrocketed, and state economies have become more service-oriented. Since most sales taxes are levied on goods (buckets, cars, ovens) but not services (lawyers, stockbrokers, office cleaners), sales tax revenue has steadily declined.

States are also facing runaway Medicaid expenses, the fastest growing line item in most state budgets. In addition, many states took on new obligations to ensure that more children have health insurance. In 2001, Medicaid expenses rose by 14%, primarily as the result of escalating prescription drug prices and rising overall medical costs.

Another factor clouding the fiscal future of states is federal tax cuts. The Bush tax cut, passed in June 2001, will begin to slice into state revenue this year. For example, even though the federal estate tax won't be fully repealed until 2010, the majority of states will lose all of their "pick-up" revenue by 2004. (Instead of states having their own estate taxes, they "piggyback" on the federal tax and share in its proceeds.) This will be a big blow to states like California, which will lose $1 billion a year in revenue, and New Hampshire, which will lose 4% of its annual revenue.

Even as the federal government pulls the revenue carpet out from under states, it is simultaneously shifting more expenses to the states. The federal government still provides a significant amount of revenue to states, in the form of block grants, but the overall pie is shrinking. As a result, state legislatures now have more responsibility for children's health, mass transit, highways, and welfare reform. New federal mandates for education testing and national security also loom on the horizon, and states will have to pick up the tab.

So what's a state to do? Unlike the federal government, every state (except Vermont) is required by its state constitution to have a balanced budget. And because so many of the problems in state budgets are structural, even an economic rebound won't pull the states out of the red in the short term.

Some states did plan for lean years and natural disasters by setting aside money from budget surpluses for "rainy-day" reserve funds during the 1990s. These rainy-day funds grew from $7 billion in 1995 to $23 billion in 2001. But a fiscal monsoon has hit, and the rapidly declining fortunes of most states will quickly deplete whatever reserves there might be.

That leaves states with two ways to balance their budgets: cut programs or raise taxes.

In almost every state in the land, major budget cuts are looming. Many states have immediately turned to cuts in spending for Medicaid services that are not federally mandated, such as dental benefits and health care for immigrant mothers. Others are slowing or cutting education spending and beginning to cut human services programs for the most disadvantaged, including poor children, new immigrants, and people with mental and physical disabilities.

Of course, as unemployment rises, this is exactly the moment when these safety nets are needed most. Yet many states would rather trim their nets than reevaluate some of the tax cuts and giveaways of the last decade. In this pervasive anti-tax climate, discussions of raising revenue are usually the last consideration—and many politicians facing reelection will be wary of raising taxes in an election year.

Only a handful of states are dealing with this new fiscal reality by delaying anticipated tax cuts. Last November in Florida, a GOP-controlled legislature postponed by 18 months a scheduled phase-out of the "intangible property tax," saving $128 million. (The tax applies to "intangibles" like stocks, as opposed to real estate or goods.) And in January 2002, the state of Virginia, facing a $892 million shortfall, voted to freeze a phase-out of the sales tax on food.

So far, only one state has had the temerity to actually raise taxes. North Carolina temporarily increased its sales tax—and introduced a new state income tax rate for the top 2% of taxpayers. The Indiana legislature is considering a tax increase on cigarettes, and a few other states may adopt tax increases as well.

But these actions do not mean that the tax burden is being distributed more fairly across class and income lines. For example, sales taxes—on food, clothing, and other items—fall disproportionately on poor and low-income people. Graduated income taxes, on the other hand, fall more heavily on the well-to-do.

This means that activists need to fight for tax equity, not just more taxes. And they are. But they have a tough battle on their hands, because most politicians aren't willing to support a shift in the tax burden from the poor to the rich.

For example, in 2000, Massachusetts voters approved an initiative to cut the state's income tax rate, assured at the time that this would not lead to cuts in services. Governor Jane Swift defiantly declared that the "tax cut would stand," even as the referendum's original business backers urged her in January 2002 to freeze its implementation in the face of a $2 billion shortfall projected for 2003. In response to the dire fiscal situation, a Massachusetts coalition of labor and community organizations is pressing for the freeze, along with reinstatement of a state capital gains tax.

A similar campaign is developing in Washington State. Washington, which has no state income tax, has one of the most regressive tax systems in the nation. The lowest-income fifth of taxpayers pay over 15% of their income in state and local taxes (such as sales and property taxes), while the top 1% of households pay less than 5% of their income. The Washington Association of Churches has convened a broad-based coalition of labor, religious, and community groups to address both the immediate budget crisis and the long-term tax equity problems that result from not having a state income tax. Its proposals for easing the short-term crunch include eliminating corporate tax loopholes. The coalition is also mounting a statewide educational campaign about the budget crisis —and about how five tax cuts over the last decade have gutted state revenue.

In Texas, a new coalition, ProTex, has also decided to make tax fairness a major focus on its work. Like Washington State, Texas has no income tax, and its tax burden is highly regressive. ProTex has launched an educational campaign to lay the groundwork for next year's legislative session. Elsewhere, Tennesseans for Tax Fairness are working to stop expansion of a state sales tax, which includes a tax on food. As an alternative, they have joined up with their Republican governor to call for the establishment of a state income tax.

These statewide organizations are not simply working to plug a fiscal gap. They are also mobilizing to make sure that, during this time of war and recession, it is not the most vulnerable and disadvantaged who will be paying the price.

Chuck Collins is Program Director of United for a Fair Economy in Boston, Massachusetts, co-author of Economic Apartheid in America: A Primer on Economic Inequality and Insecurity (New Press, 2000), and a member of the Dollars & Sense collective.

Resources: National Association of Governors; National Conference of State Legislatures; Center on Budget and Policy Priorities (and State Fiscal Analysis Initiative)