February 11, 2009

State Budget Shortfalls Present a Tax Reform Opportunity

Download Special Report 164

Special Report No. 164

Key Findings

Forty-five states face budget shortfalls of varying degrees, totaling approximately $132 billion through fiscal year 2010. However, every state but one expects revenues in 2010 to be higher than in 2006, and all but nine states have seen revenues grow faster than inflation from fiscal years 2006 to 2009.

States hit hardest are those that relied most heavily on growth in unstable revenue sources like taxes on capital gains, high-income earners, and corporate profits.

Punitive taxes on unpopular groups, such as smokers, drinkers, or high-income earners, are poor tax policy and a source of instability because they force a small group of people to pay for government services broadly available to all citizens. Shifting the burden of paying for these programs away from most taxpayers can result in demands for more government than people are actually willing to pay for.

State and local officials are more frequently using the “Washington Monument” ploy-threatening to cut politically popular services to create pressure for tax increases.

Broadening tax bases, lowering rates, and eliminating targeted tax credits can generate extra revenue without unduly harming a state’s economic performance.

A tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.

The tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates.

A tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly.