The Week in Public Finance: Federal Tax Reform Fuels Record State Spending

Budget directors are still figuring out how much of the tax law's impact on state revenues was a one-time boost.
by | November 16, 2018
Stack of cash.
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SPEED READ:

  • According to the National Association of State Budget Officers, state spending topped $2 trillion in fiscal 2018, a record high.
  • The spending increase is largely driven by higher income tax revenues that resulted from last year's federal tax changes.
  • Much of the extra money has gone toward Medicaid and transportation, but education also received significant funding boosts.
 

State spending and revenues soared in 2018, thanks in large part to policy changes at the federal level.

The tax overhaul last year boosted income tax revenues for states, and a new federal budget freed up more money for domestic programs.

Total expenditures across the 50 states last fiscal year topped $2 trillion, a record high. While that includes a 4.6 percent boost in spending from states' own money, funds from the federal government grew by nearly 6 percent. Increases in federal funding of state programs have generally gone toward Medicaid. However, non-Medicaid spending increased by 4.5 percent in fiscal 2018, according to the state expenditures report released this week by the National Association of State Budget Officers (NASBO).

“It used to be that, without Medicaid, we were seeing a decline in federal spending,” says Brian Sigritz, NASBO’s director of state fiscal studies. “But that wasn’t the case this year.”

On the revenue side, the federal tax overhaul prompted many taxpayers to file some of their 2018 taxes early, leading to a one-time bump in revenue. Total revenue for fiscal 2018, which ended on June 30 for most states, was $838 billion. That’s a more than 6 percent increase over the prior year and the highest growth rate since fiscal 2011.

It remains to be seen, however, whether states will continue to see a revenue boost from the tax overhaul in 2019 and beyond. For high-income earners who tend to file quarterly returns, a new lower federal tax rate means more income to declare — and tax — at the state level. While some states have reacted by changing their own tax policy to have a revenue neutral effect, not all have.

The income tax boon was most evident during the first three months of 2018, according to a separate report from the Urban Institute’s Lucy Dadayan. During that period, income tax revenues grew by a whopping 12.8 percent after adjusting for inflation. Overall, individual income tax collections increased in 38 states during that quarter, with 23 of them reporting double-digit growth.

Connecticut, Illinois and Kansas saw particularly strong growth; income tax revenue increased by 51.4 percent, 43.2 percent and 66.6 percent, respectively.

Kansas’ and Illinois’ growth is mostly attributable to state increases in income tax rates while Connecticut’s was more of a one-time boost from the new federal tax provision that encourages companies to bring their foreign earnings back to the United States. Connecticut is home to a large number of hedge fund managers who scrambled to bring overseas profits back into the states by the end of 2017. It was the only state that taxed that amount in full at the close of last year.

NASBO Executive Director John Hicks says whether or not the revenue boost is a fluke will be clearer for states by spring of next year. “States are still trying to untangle the one-time nature of this revenue bump," he says, noting that the good economy is also playing a role in higher income tax receipts.

In terms of spending, states invested nearly 9 percent more of their own funds in transportation. The biggest increase came from California, which spent an additional $3.1 billion on a massive, decade-long building program that will ultimately cost $54 billion.

Education funding also saw a boost this year, of 4.6 percent, a growth rate higher than in 2017. Given all the attention this year on teacher salaries and education funding, Hicks says they expect that growth to continue into 2019.

 

In other public finance news this week:

Paradise’s Uncertain Financial Future

Californians are -- unfortunately -- used to wildfires. As such, they rarely affect a locality’s finances. But that’s not true this time.

The Camp Fire in Northern California has raged through the Sierra Nevada Mountain foothills over the past week, destroying the town of Paradise. Meanwhile, a pair of Southern California fires, Hill and Woolsey, continue to threaten communities surrounding Los Angeles, including Malibu.

S&P Global Ratings this week placed Paradise's school and irrigation districts on a negative watch, meaning they could be downgraded in the coming months. “While the full extent of the damage is currently unknown,” S&P said, “we believe that a significant portion of the district’s housing stock was destroyed, potentially affecting student enrollment and the state funding that students generate.”

But it doesn't have to be all bad news. In 2007, an EF5 tornado cut through the center of Greensburg, Kan., and destroyed 95 percent of the roughly 1.5-square-mile town. Through ingenuity and hard work, what could have been the death of a town turned into its rebirth, largely because of a unique plan to turn the farming town, once only famous for the world’s largest hand-dug well, into a world model for sustainable, environmentally friendly development.

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