Research by Author & Topic

Publications by Elaine Maag on State and Local Issues

Every state except Vermont operates under some sort of balanced budget requirement. That means that to serve the increased need of distressed populations during recessions, states must either increase revenue or reallocate resources dedicated to other programs. Similarly, when revenue declines, states must raise taxes or reallocate resources. This report examines the extent to which rainy day and general fund savings were a significant factor in helping states cope with fiscal stress during and after the 2001 recession, a possible explanation for the lower than expected legislated tax increases and social welfare cuts.

Owing to balanced budget requirements, states often raise taxes during recessions. Unless carefully crafted, these tax hikes can fall on low-income working families--the same families likely to be subject to concurrent budget cuts. During the recession that started in 2001, states utilized several tools to balance budgets including tapping rainy day funds, borrowing, increasing taxes, and cutting spending. In many cases, low-income families were shielded from tax increases by increasing or creating state Earned Income Tax Credits (EITCs). This policy brief details state tax changes affecting low-income families between 2002 and 2006.

States use rainy day funds (RDFs), or budget stabilization funds, as a cushion against financial shocks. Every state except Vermont has some sort of balanced budget requirement so that, unlike the federal government, they must balance expenditures and revenues in any given budget cycle (typically one year). States can have RDFs that allow money to be carried over from good years to lean years. Five states--Arkansas, Colorado, Illinois, Kansas, and Montana--do not have RDFs.

Several mechanisms, including traditional tax limits and legislative supermajority requirements, can limit the authority of states to increase or pass new taxes. As of February 2006, six states have a traditional tax limit in place and sixteen states require supermajorities. Eleven states are considering the adoption of new limitations or the expansion of existing restrictions.

Child care's costs can be too high for low-income working families. As of 2004, along with a federal credit for child care expenses, 27 states offered tax credits or deductions to offset these expenses. Thirteen states offered a refundable child care credit—at least for low-income families; twelve states, care credits that were non-refundable; and three states, a deduction of child care expenses (Maryland offered both a non-refundable credit and a deduction).

This analysis of seven states (California, Colorado, Florida, Michigan, Mississippi, New Jersey, and Washington) shows that the severity of the current revenue crisis far exceeds that of the recession that triggered it because states cut taxes and expanded programs based on unsustainable revenue growth during the late 1990s. All of the states studied responded to revenue declines with short-term solutions -- using reserves, transferring other funds to the general fund, refinancing debt, and shifting expenditures or revenues across fiscal years. All but New Jersey and Washington cut spending. Only New Jersey relied heavily on tax increases. The authors suggest that states should be realistic about the sustainability of future revenue trends and should not count on federal help. States should also build up reserves and be able to draw on them when needed, and should make tax policies symmetrical rather than place special barriers against tax increases.

We compare state tax policy responses to the recessions that began in July 1990 and April 2001. Tax revenue declined more in the 2001 recession even though the output shock was smaller. In the early 1990s, states quickly altered tax policy to replace a large share of lost tax revenue. In the recent recession, states have made few tax policy changes to enhance revenue except for increasing tobacco taxes. We present some reasons for this behavior and argue that states are on the verge of missing an opportunity to improve their tax systems.

This paper discusses how state income taxes and sales taxes affect the working poor. While some states impose substantial burdens through income taxes with low thresholds and/or sales taxes that do not exempt necessities, others provide generous subsidies through refundable earned income tax credits similar to the federal earned income tax credit. A few states go beyond the federal model and also provide refundable child care credits. In evaluating the role of tax policy to assist low-income people, policymakers need to study the incentives and disincentives associated with various features of the tax system.