Navigating State and Local Finances

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From Lincoln Institute of Land Policy, Land Lines, October 2007. Reprinted with permission.

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Abstract

This article summarizes a March 2007 TPC-Northwestern conference examining state and local finances.

Navigating State and Local Finances

Past trends will not foretell the future, but charting how state and local finances weathered the 2001 recession suggests viable ways to navigate going forward. Lacking the deficit finance ability of the federal government, states and localities must set a spending course based on anticipated taxes and revenues. An unexpected crisis—like the stock bubble burst at the beginning of this century and the subsequent economic slowdown—that throws budgets into fiscal chaos requires such unpopular bailouts as tax increases or cuts in services and welfare. Did that happen?

Participants at a Lincoln Institute-sponsored conference in March 2007 gathered at the Urban Institute in Washington, DC, to discuss the recession and share findings on how states and localities determined various actions and policies to address its impacts. This conference, titled "State and Local Finances after the Storm: Is Smooth Sailing Ahead?", was also hosted by the Urban Institute-Brookings Institution Tax Policy Center, and by the Kellogg School of Management and the Institute for Policy Research, both at Northwestern University.

A prior conference in April 2003 focused on what we do and do not know about state fiscal crises. Although the economy takes a downturn about once a decade, policy makers continue to be caught unprepared. The recession of 2001 was further exacerbated by tax reductions enacted by state governments in the boom period of the late 1990s and by spending accelerations.

The personal and corporate income taxes and the sales tax all yielded lower revenues in 2002 than in the previous year, according to research presented at that 2003 conference. At this year's conference, we learned that the corporate income tax rebounded as a share of state tax receipts starting in 2003, but that the effective tax rate on corporate profits has slipped even further.

Presentations also noted that substantial rainy day funds in some states may have staved off broadbased tax increases and protected social services for low-income families. Cities don't have rainy day funds, however.

Many cities found that the resilience of property taxes proved to be the great equalizer as states and localities faced large declines between available revenues from other sources and the resources needed to maintain services. Yet, as a case study of Minnesota showed, no two cities respond to fiscal crises in exactly the same way. For example, more than 38 percent of Minnesota's cities relied more on increased service charges than on property taxes (Anderson 2007).

Cutting funds to K-12 education is perhaps the most unpopular way to reconcile local budgets during a recession. However, new numbers presented at the 2007 conference showed that while state and local education spending trended slightly upward in 2002, it dipped briefly in 2003 and 2004. Many localities' direct education spending has recovered; states, however, have not returned to pre-recession education spending levels.

What are the budget busters going forward?

(End of excerpt. The entire article is available in PDF format.)

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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