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Race to the Bottom?

New Jersey’s pension problems and Illinois’ lack of a budget continue to dog their reputation in the eyes of creditors.

In New Jersey, Moody's downgraded the Garden State one-notch this week to A3, citing the state’s “significant pension underfunding, including growth in the state's large long-term liabilities, a persistent structural imbalance and weak fund balances.”

It’s the 11th downgrade by a credit rating agency during Gov. Chris Christie’s more than seven years in office. Overall, New Jersey’s credit rating has fallen four notches under Christie’s watch, from what’s considered high investment grade to borderline medium grade. Meanwhile, the state's unfunded pension liability has climbed to $136 billion, which mean it has less than half of what it needs to pay its retirees down the road.

For its part, Illinois is the only state rated lower than New Jersey. It holds a BBB rating -- just two steps above junk bond status. It has also suffered multiple downgrades this decade after being reasonably stable in the 2000s. But the state’s failure to pass a budget since Gov. Bruce Rauner took office in 2013 and went to battle with the legislature to curb spending has increased the pace of downgrades. With no serious truce in sight, municipal market analyst Matt Fabian warned this week that no formal budget in fiscal 2018 “could lead to a historic downgrade of the state below investment grade.”

The Takeaway: These two states are making financial history and not in a good way. For New Jersey, Christie surpassed his own record for the most rating downgrades under any previous governor. And for Illinois, hitting junk bond status would be a first in the modern ratings era and significantly raise its future borrowing costs.

The common denominator here is budget sustainability, or lack thereof. Both New Jersey and Illinois have been repeatedly dinged for their increasing pension liabilities. For the better part of this decade, these states have employed one-time solutions to balance their budget. In fact, “choosing to operate without a budget," Fabian adds, "is perhaps one of the largest budget gimmicks available to a state.”

Best Returns on Taxpayer Investment

When it comes to where taxpayers get the best bang for their buck, New Hampshire rises to the top. That’s according to an analysis released this week by WalletHub, which looked at taxpayer return on investment per state. Filling out the top 10 spots were: South Dakota, Florida, Virginia, Alaska, Colorado, Utah, Missouri, Texas and Nebraska.

The study looked at taxes per capita and the quality of services taxpayers get in exchange. Water quality, schools, the violent crime rate, and roads and bridges were among the criteria used to determine the ratings. Overall, the study found that taxpayers in red states, which tend to have low tax rates, get a better ROI than their blue state counterparts.

The Takeaway: There is a notion in public finance that each state’s tax policy tends to fall somewhere on the spectrum of low tax, low service and high tax, high service. The idea is that taxpayers essentially get what they're paying for. That means that some of the top-ranked states might not have great services because taxpayers are paying very little for them.

Take Alaska, which makes the top 10 because of its incredibly low tax rates -- the state doesn't tax sales or income and has the lowest taxes per capita in the country. But it also ranks dead last in terms of services. Nebraska, on the other hand, has an averaging ranking in taxes per capita but ranks fourth in government services.

The lowest-ranked states don't meet the get-what-you-pay-for test. California, Hawaii and New York have middling service quality but some of the highest taxes per capita in the country, according to the study. And Arkansas and New Mexico have slightly-higher-than-average taxes but some of the worst service quality in the country.

A New Tax Trend?

As states look to close budget gaps for the current and upcoming fiscal year, the idea of taxing business’ overall sales figures is getting more attention.

The approach is called a gross receipts tax and only five states (Delaware, Nevada, Ohio, Texas and Washington) even have one. But the idea is being contemplated in four new states: Louisiana, Oklahoma, Oregon and West Virginia.

The consideration in Oregon comes just months after voters rejected a ballot measure that would have imposed a tax hike on corporations with more than $25 million in annual sales in the state. Unlike the other three states where this is being considered, Oregon doesn’t have a sales tax.

The Takeaway: There’s a reason not many states go this route and that's because there are a lot of concerns about double taxation -- taxing both the company’s sales and goods at the point of sale. State officials worry that companies will simply pass on this extra cost of doing business to the consumer. That threat was the main reason the gross receipts ballot measure failed in Oregon.

The upside is that a gross receipts tax captures a state-based business’ overall activity. That means it is a more stable source of revenue for governments than a sales tax, which fluctuates with consumption. Nicole Kaeding from the Tax Foundation, however, urged  policymakers to consider other options for revenue stability “such as a properly structured sales tax” or expanding their current tax base. The gross receipts tax has had mixed results in the states that have tried it.

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