Finance

Low-Flow Revenue Stream

When some labor unions in Rockford, Ill., came out in support of an increase in the local sales tax last month, it wasn't big news....
by | March 31, 2007

When some labor unions in Rockford, Ill., came out in support of an increase in the local sales tax last month, it wasn't big news. But when they were joined by the Rockford Chamber of Commerce, the local Realtors association and some other groups in endorsing a one-penny hike in the tax for roads, it was a bit more unusual.

Just a week earlier the governor, Democrat Rod Blagojevich, had proposed the largest tax increase in Illinois history, to fund a $60 billion budget for fiscal 2008 -- an increase of 7 percent, largely to cover new education initiatives as well as an expansion of medical coverage to 1.4 million adults who now lack insurance.

Next door in Indiana a few days later, Gov. Mitch Daniels, a rock-solid conservative who ran the Office of Management and Budget during George W. Bush's first term, led a rally at the statehouse for a 25-cent increase in the cigarette tax to fund health initiatives. Daniels assured the crowd that "there are enough votes in this building to pass this plan." The Republican governor of Connecticut, M. Jodi Rell, went even further, surprising her legislature by proposing not only a 49-cent hike in the cigarette tax but also a 10 percent increase in the state income tax for increased education funding.

And in New Mexico this month, voters in Doña Ana County narrowly approved a small increase in their gross receipts tax to raise almost $50 million for Spaceport America, which is planned as a base for Virgin Galactic, a project by British tycoon Richard Branson to launch suborbital rocket flights within two years. The plan has the enthusiastic support of Gov. Bill Richardson, a contender for the Democratic presidential nomination, who himself has proposed an 11 percent increase in state spending this year, including $125 million for the spaceport.

If all this sounds a little otherworldly in an anti-tax nation, the overall numbers tell the story. The Tax Foundation recently reported that "state and local taxes will consume a record-setting 11 percent of the nation's income in 2007," which would be the highest level since the organization began tracking such data.

As Washington tries to tighten its belt after years of tax cutting, heavy spending and chronic deficits, the fiscal situation in the states seems to be trending in the opposite direction. Preoccupied by a lengthy war, the federal government has been ceding many priority domestic initiatives to the states and their localities. Governors and local leaders in both parties are responding with ambitious agendas to confront the nation's most pressing problems, particularly expansions of health care programs, funding for preschool and all-day kindergarten, and financing to build schools, roads and prisons. In some states, among them New Jersey and Illinois, governors and legislatures also face serious deficits in their public pension plans, with the day of reckoning growing ever closer as retirements accelerate.

Putting Toll Roads to Work

For the past few years, revenue has been gushing in, especially from taxes on incomes, corporate profits and property. But now in some states it's showing signs of slowing. In Florida, for instance, the real estate market is slumping fast, and state economists are warning that revenue will probably decline from last year. It isn't disastrous, given that the state has $3 billion in reserves to cover a predicted $1 billion shortfall. But it's a sign that the years of easy revenue are ending.

So now that the expectations for increased spending on popular programs are running high, what are states and localities going to do? Many places are trending toward increases in taxes, fees and borrowing -- as well as a few more esoteric maneuvers, among them privatizing revenue-producing assets such as toll roads and even state lotteries. Indiana's Daniels and Mayor Richard Daley of Chicago have already signed long-term leases of key assets; the governors of Illinois, New Jersey, Pennsylvania and Texas are pushing to do the same.

The tax increase of choice is the one on cigarettes: 14 states are considering that. Also popular is, in effect, a swap: higher sales taxes for relief from property taxes, which have been soaring in many states during this decade's huge run-up in home values. A lot of governors want to expand sales taxes to cover more services, particularly because states are losing so much revenue to Internet retail sales -- and you still can't get your hair cut on eBay.

Both states and localities have been increasing fees steadily for years, but now it's clear that such states as California and Texas will rely increasingly on tolls to help fund transportation infrastructure, including projects undertaken by public-private partnerships. Then there is borrowing. Last year the municipal bond market exceeded $400 billion in volume, and this year the Securities Industry and Financial Markets Association is predicting that new issues (not including refinancing) will grow from $257 billion to $275 billion.

So revenue from taxes, fees and borrowing is up, with more coming from long-term leases of assets. Spending has surged as political leaders try to meet demands for key services. The question now is: What happens when the economy slows down and revenue takes its inevitable dive?

Peter Harkness
Peter Harkness  |  Founder, Publisher Emeritus
pharkness@governing.com

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