Three Characteristics of Tax Structures Have Contributed to the Current State Fiscal Crises

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There is no single cause of the state fiscal crises at the beginning of the 21st century. The requirement that states balance their budgets¹ combined with relatively rapid expenditure growth, the specific characteristics of their tax structures, and poor long-term fiscal planning have conspired to leave states in very difficult fiscal straits. Most states probably could have limited the extent of problems with very careful planning, such as through the use of much larger rainy day funds, a longer-term perspective in the tax policy decisions that were made during the 1990s, and other mechanisms to smooth their expenditure patterns. Nonetheless, on a year-over-year basis the revenue pattern of the past three years appears to be closer to a 100-year flood than to a 10-year flood, so states would have needed to plan throughout the 1990s to avoid fiscal problems.² By 2000, it was too late for states to save enough for the current rainy day. This report investigates one of the causes of the fiscal dilemma, the structure of state taxes, and the role that it has played in the current fiscal crises.

The report begins with a review of recent state revenue performance. The second section contains a description of three key characteristics of state tax structures that determine how tax revenues respond to economic growth. The final section concludes by putting these factors together to analyze the implications for the future.

Notes from This Section

1. Fox and Murray (1997) discuss why balanced budget requirements are much less restrictive than may be thought.

2. During 2002, states' real decline in tax revenues was significantly greater than any year since at least 1970. Revenue growth has been negative in real terms for two consecutive years, though the revenue malaise has not as yet been as prolonged as the experience of 1980 through 1983. But revenue growth during the first half of fiscal 2003 suggests another year of growth that is negative in real terms.

Note: This report is available in its entirety in the Portable Document Format (PDF).

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

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