State Finances: Short-Term Gains Won't Outweigh Long-Term Pain

Preliminary tax data from the Nelson A. Rockefeller Institute of Government for 45 states shows revenues are up nearly 13 percent from last year.
May 1, 2013

After coffers were buoyed by a swell in income tax revenues at the end of 2012, state governments braced for a dry start to 2013. Happily for most, that expectation proved to be false – at least for now.

Preliminary tax data from the Nelson A. Rockefeller Institute of Government for 45 states shows revenues are up nearly 13 percent over January and February of 2012. And that’s largely due to income tax collections, which are 23.6 percent higher, according to the data. While that’s good news for states, analysts are still cautioning that a larger structural problem remains:  governments must figure out how to survive in this era of austerity because the U.S. economic boon before the recession isn’t coming back any time soon. If ever.

As Janney Montgomery Scott analyst Tom Kozlik noted in his April state fiscal health update, nationwide tax receipts are still well below pre-recession levels when adjusted for inflation. While it shows how resilient states have been since 2008, the “result really serves to reinforce the magnitude of the weakness faced by the US economy as a whole as a result of the Great Recession,” he wrote.

The Rockefeller Institute also signaled that the January/February returns may just be a holdover from the increase reported at the end of 2012, “given that taxpayers make estimated payments in January in many states.” That increase was due to anticipated tax changes in 2013.

Looking at the larger picture, the U.S. Government Accountability Office is still maintaining that the fiscal position of state and local governments will “steadily decline through 2060 absent any policy changes.” The April update to its State and Local Governments’ Fiscal Outlook report, released this week, warns that total tax revenues for governments as a percentage of Gross Domestic Product (GDP) will remain below the historical high set in 2007 at least through 2060, due to modest growth in receipts. Additionally, governments will have to continue to adjust to a reduced level of federal assistance following the stimulus in 2009 and 2010 from the American Recovery and Reinvestment Act.

“[D]eclining fiscal conditions shown in our simulations continue to suggest that the sector would need to make substantial policy changes to avoid growing fiscal imbalances in the future,” the report states. Otherwise, states and local governments “would face an increasing gap between receipts and expenditures in the coming years.”

Although not suggesting what policy changes should take place, the report goes on to note that the primary driver of fiscal challenges for governments in the long term continues to be the cost of health care for retirees and employees and for the poor (Medicaid). The GAO predicts that costs will nearly double as a percentage of GDP over the next five decades: from 3.2 percent of GDP in 2013 to 7.2 percent in 2060. Eventually, that would nearly match all other non-health-related costs (primarily worker salaries) as that expenditure is expected to decrease from 10.5 percent of GDP this year to 7.7 percent in 2060.

However, Wells Fargo analyst Natalie Cohen offers a glimmer of hope for health care in finding a silver lining around the expected increase in interest rates in the coming years. In her commentary this week on the municipal market, she wrote the rising rates could actually give a boost to pension funds. “This could, in turn,” she stated, “soften the burden on municipalities that face higher pension payments to make up for a long period of lackluster earnings.”

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