State Tax Revenues Are Higher Than Ever, But Good Times May Not Last

Federal tax reform and the economy are boosting state coffers -- for now.

1040 tax form, pen, us money and flag
(Shutterstock)

SPEED READ:

  • In 41 states, income tax revenues surpassed pre-recession peaks last year.
  • The rise is largely due to federal tax reform and the strong economy.
  • But so far this year, income tax revenues are lower than expected in 19 states.
 
States’ purchasing power has never been better, but there are signs that the upswing is waning.

A record 41 states collected more revenue last year than they did before the 2008 recession, even when inflation is taken into account. And in many cases, the recovery is significant. In 16 states, tax revenue was at least 15 percent higher in the third quarter of 2018 than their last peaks.

The findings come from the latest analysis of state revenues by the Pew Charitable Trusts. Collectively, states during the third quarter of last year had the equivalent of 13.4 cents more in purchasing power for every $1 they collected at their recession-era peak.

 
income-tax-pew-chart2.jpg

SOURCE: The Pew Charitable Trusts

 
Experts point to two main reasons that state tax revenues are up: the 2017 federal Tax Cuts and Jobs Act, which enticed many taxpayers to pay certain taxes in late 2017 rather than early 2018, and the robust economy, which has kept stock market returns and income tax collections up.

In addition, some states have hiked taxes to boost revenue. That’s a big reason why, for example, Connecticut’s revenue has recovered while New Jersey’s hasn’t. Both states have similar demographics, a slower economy and high taxes. But New Jersey reduced its sales and corporate taxes in recent years while Connecticut raised those two taxes and increased income taxes.

"Federal tax reform is just one of three major drivers when it comes to state revenue," says Pew’s Justin Theal. "Economic conditions and state policy are the others."

 

Trouble Ahead?

Despite last year's numbers, preliminary figures of tax collections in more recent months cast a cloud over this sunny picture. Sales and corporate tax revenues are remaining steady, but income tax collections are missing the mark in nearly half the states.

According to data compiled by the Urban Institute's Lucy Dadayan, income tax revenues were lower than expected in 19 states heading into tax season. On average, there is a 2.2 percent income tax revenue gap those states have to make up before the current fiscal year ends on June 30 (for most places).

California, Idaho, Massachusetts and New York were facing the biggest gaps between income tax revenue and expectations, ranging from nearly 12 percent in Idaho to 6 percent in Massachusetts.

All of this means that even though forecasters in most states factored in taxpayers’ responses to the 2017 federal tax law, they still overestimated the growth in income tax revenues. While states hope that tax payments filed this April will make up the difference, there are still other areas of uncertainty affecting future revenues, including a global economic slowdown, volatility in stock markets, rising interest rates and economic risks associated with trade disputes.

"If income tax returns fall short this April, it would be prudent for state officials to revisit longer-term fiscal planning strategies," says Dadayan. "Individual and corporate taxpayer behavior will undoubtedly continue evolving in the next months and even next few fiscal years."

Liz Farmer is a former GOVERNING fiscal policy writer.
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