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<i>The Week in Public Finance:</i> For State Budgets, What a Difference 6 Months Make

Thanks in large part to a steady economy, states are finishing 2018 better than they expected.

Nearly one-third of state spending increases in fiscal 2018 are going toward K-12 education.
(David Kidd)
After two straight years of lackluster revenue growth, state finances are on the upswing thanks in large part to a stable economy and a one-time boost from December's federal tax overhaul.

As fiscal 2018 comes to a close on June 30 in most states, total revenue growth for the year is estimated at 4.9 percent. That's the best year since 2015, according to the latest state fiscal survey from the National Association of State Budget Officers (NASBO). 

The numbers bear that out: Only nine states have been forced to make mid-year budget cuts compared with a whopping 22 last year. Cuts totaled just $830 million in fiscal 2018; a year ago, states had to cut $3.5 billion to balance budgets. And 19 states have increased spending this year to the tune of $1.6 billion, which boosted total spending growth by 3.4 percent or to $835 billion.

Much of the better-than-expected performance is being credited to a continually improving economy and booming stock market. Corporate income tax revenues posted a more than 3 percent increase after two straight years of declines.

States also saw a spike in personal income tax collections as many high-income taxpayers rushed to take advantage of expiring federal tax breaks under the December overhaul. “States are still working to untangle and better understand these trends and the impact of the federal tax law on their revenues,” the NASBO survey reported.

The picture looked a lot bleaker six months ago: States collectively projected just 2.3 percent growth -- the lowest spending increase since the Great Recession -- and 15 states had budgeted a spending cut in fiscal 2018.

With the turnaround, even states that have dealt with chronic deficits caught a break. Connecticut, for example, collected $1.3 billion more in income tax revenue than it expected to, according to Paul Potamianos, the state’s executive budget officer. That boost allows the state to make its first meaningful deposit into its meager rainy day fund since the recession.

Rainy day savings are a top priority for states as the national economy nears the longest expansionary period in the modern era. By the end of next year, states on average are projected to have more than 6 percent of their general fund spending stocked away in savings. It’s a build up that has steadily progressed since a low of less than 2 percent in 2011.

“That’s the place I’d like to be as a budget director,” Potamianos said in a conference call with reporters this week about Connecticut’s planned rainy day fund boost. “Having a little bit of a net under the tightrope because at some point, the next recession is going to come.”

In addition to socking some revenues away in rainy day funds, states are also planning to increase spending in fiscal 2019 by 3.2 percent, or $26.5 billion. Nearly one-third of that increase is going toward K-12 education, a topic that dominated some states this spring, particularly in places that have failed to restore funding cuts since the recession.

In Kansas, one of several states that saw a teacher strike, more than half of the recommended $190 million spending increase next year will go toward education. North Carolina, meanwhile, is boosting education funding by nearly $340 million, mainly for teacher and principal pay raises.

Still, after years of slow revenue growth, states remain cautious. They're projecting only a moderate revenue increase of about 2 percent.

But that estimate could change.

Two U.S. Supreme Court decisions may affect next year’s revenues. Earlier this month, the court ruled that states can legalize sports betting, which could cause a small revenue boost in some states next year. And in the coming days, the court is also expected to rule on a landmark case that could force all online retailers to remit sales taxes to states. According to the federal Government Accountability Office, such a ruling could increase annual state and local lost revenues by as much as $13.5 billion.


In other public finance news:

Another Rate Hike

The Federal Reserve hiked short-term interest rates by a quarter percent this week and signaled that more increases may be on the way. Citing a strong job market, growth in household spending and increased business investment, the Fed raised the target interest rate to a range of 1.75 to 2 percent. The last time the rate topped 2 percent was in the summer of 2008.

While the cost of goods and services may rise for governments, the rate hike will have little affect on municipal market borrowing. For starters, any government refinancing debt will still be doing so at a low interest rate. In addition, the Fed’s decision only impacts short-term interest rates. So, issuing short-term debt might cost a little more but long-term debt is likely to be unaffected. In fact, sometimes a hike in short-term rates can actually cause a downward tick in long-term rates -- saving money for governments in the long run.


Seattle Repeals Head Tax

Less than a month after unanimously passing a controversial head tax on big businesses, the Seattle City Council repealed it in a 7-2 vote this week. The tax, which many saw as targeting internet commerce giant Amazon, would have levied a $275-per-employee tax on companies that gross over $20 million a year. The estimated $50 million per year it would have generated was intended to help the city address housing affordability and homelessness.

But, faced with a "No Tax on Jobs" campaign funded primarily by Amazon and Starbucks to repeal the tax via a voter ballot initiative, the council hastily changed its mind. Councilwoman Lisa Herbold said a protracted political fight was “not winnable at this particular time,” adding, “the opposition has unlimited resources.”

The startling reversal shows how difficult it is becoming in progressive-minded cities to tackle their growing housing affordability problem. Although larger companies can put a strain on public services, Tax Foundation Senior Policy Analyst Jared Walczak noted in a statement that the way a jurisdiction raises revenue -- not just the amount -- matters. If you tax something, you get less of it, Walczak said. “Seattle residents understood that penalizing employment was bad for their community, and their elected officials seem to have gotten the message,” he added.

To read this regularly, subscribe to "The Week in Public Finance" newsletter for free.

Liz Farmer is a former GOVERNING fiscal policy writer.
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