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<i>The Week in Public Finance</i>: Some States Are Less Prepared for a Recession Than a Decade Ago

But according to two analyses, a majority of states have nearly enough savings to weather a downturn.

Some of the least prepared governments, such as Pennsylvania, have repeatedly struggled to balance budgets, even as the economy has recovered.
(David Kidd)
A decade after the worst financial crisis in modern American history, two separate analyses of government finances have found that most states are better prepared to weather the next recession.

S&P Global Ratings and Moody’s Analytics have concluded that a majority of states have either adequate funds or almost enough to make it through the next recession without the massive layoffs and draconian cuts governments had to resort to following the 2008 global financial crisis.

But both firms also discovered a disturbing trend: A subset of states have continued to struggle and remain worse-off than they were a decade ago. “All else equal, this is going to result in a faster recovery [compared with 2008] among the states that are most prepared,” says Dan White, a director at Moody’s Analytics. “What’s troubling, though, is we’re seeing an increasing gap between the have and have-nots.”

S&P and Moody's stress-tested state budgets in their analyses. The idea, which was borrowed from the U.S. Federal Reserve, is to essentially throw different economic scenarios at a state budget to see how revenues would be impacted. Analysts found that states with a progressive income tax structure or states that are dependent on a volatile revenue source, such as oil and gas, tend to have more wild revenue swings in the event of a fiscal shock.

A total of 20 states have enough in reserves to get through a downturn comfortably, according to S&P. Moody’s found that 23 states are well-positioned when including other funds available to buffer the budget. That’s up from the 16 states Moody’s found last year when it issued its first stress-test analysis. Both analyses found that roughly a dozen states almost have enough in reserves to weather a moderate downturn.

But both analyses noted that an alarming number of states are still unprepared to get through even a moderate downturn without resorting to cuts. Moody’s found 17 states are in that category, up from 15 states last year. For S&P, 18 states have less than 70 percent of the reserves they need to absorb a fiscal shock.

This gap between prepared and ill-prepared governments holds true for cities as well. PNC Capital Markets analyst Tom Kozlik has previously noted that as much as 20 percent of state and local governments have seen their underlying credit quality decline -- some significantly so. Meanwhile, a Brookings Institution report released this summer notes that populous cities with a higher demand for services are more likely to have a harder time quickly adjusting to the budget pressures created by a recession.

On the state level, S&P Analyst Gabriel Petek says tax and income trends have conspired to create a more volatile revenue environment over the past decade as states have become more reliant on income tax revenue. That means that in the event of even a moderate recession, state budget shortfalls could be higher in some places than during the 2008 crisis.

Some of the least prepared governments -- namely, Illinois, Louisiana, New Jersey and Pennsylvania -- have repeatedly struggled to balance budgets, even as the economy has recovered. But even among these states, some will be hit worse than others, says Moody's White.

For example, Pennsylvania has a flat income tax, which means its revenue is less volatile and therefore is predicted to see no more than a 7 percent drop in revenue. New Jersey, on the other hand, "has a much more progressive income tax so its fiscal shock [could be] nearly 13 percent,” White says. “They have a much larger target to hit than Pennsylvania does.”

On the plus side, both firms note that governments have time to get ready. Economic forecasts predict the economy will continue to grow or be stable over the next year.


In other public finance news:

Will Congress Regulate States' Online Sales Taxes?

Three months after states successfully argued before the U.S. Supreme Court for the right to collect sales taxes for all online purchases made by their residents, Congress is getting involved.

A bill introduced this month includes an exemption for businesses that generate less than $10 million in annual U.S. e-commerce sales. It also prevents states from collecting sales taxes before Jan. 1, even though many states have already started collecting taxes or are scheduled to start in October.

The National Conference of State Legislatures (NCSL) and others argue that sales tax implementation should be left to the states. "Congress’ proposal," NCSL said in a statement this week, “would hinder state implementation efforts, preempt state authority, and create more problems than solutions.”

But others are concerned about the administrative burden to small businesses and online mom and pops. Indeed, some states have complex taxing structures, making implementation complicated.

The bill’s sponsor, Rep. Jim Sensenbrenner, a Wisconsin Republican, said in a statement that the bipartisan legislation “reins in the taxation free-for-all” created by the Supreme Court. “Online sellers need clarity and stability in the sales tax arena,” he said. “Our bill will protect small businesses and internet entrepreneurs from excessive regulatory burdens.”


Do Soda Taxes Work?

This question has hovered over the still-burgeoning practice of taxing sugary drinks to discourage consumption. Now, new research on Philadelphia’s soda tax by Mathematica Policy Research, has shed some light on the answer.

It found that after the soda tax went into effect more than a year ago, residents' buying habits shifted. Instead of buying taxed beverages in the city, residents bought more taxed beverages outside of it.

In fact, the percentage of Philadelphians reporting that their usual source of beverage purchases is outside the city increased by 17 percentage points, to roughly 33 percent. The full research was published this week as part of a National Bureau of Economic Research working paper.

The findings may provide fuel for those who have opposed the tax and claim that it will only hurt Philadelphia businesses.

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Liz Farmer is a former GOVERNING fiscal policy writer.
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