Can It Get Any Better Than This?

Prosperity abounds as the national economy continues its record-setting pace. When times are good, everyone has something to celebrate.

What do black fly control, Georgia's World Congress Center and a courtroom of the future have in common? They are all beneficiaries of the economic boom sweeping the country.

The current economic expansion, which began in March 1991, has put most states in their healthiest financial position in decades. With each passing year, the fiscal outlook has improved. Now, between the unspent revenues in their general funds and the growing balances in their rainy day funds, state reserves top 9 percent, a level last seen 20 years ago.

"It's hard to believe that this economy continues to perform so well," says Assemblyman Paul Tokasz of New York. "It makes for an interesting dynamic. We're moving forward with confidence, yet glancing back occasionally to see when the other shoe is going to fall."

For now at least, state revenues are piling up, and policymakers have scrambled to allocate them. Their decisions on what to do with the extra funds have been diverse and creative, with almost every interest getting a share.

GIVE IT BACK

Taxpayers in most states are enjoying another round of tax reductions. Lawmakers reduced taxes by almost $5 billion in 1999, marking the fifth consecutive decrease. Although the aggregate reductions have been modest each year - representing about 1 percent of total tax collections - several states have slashed taxes significantly. Altogether, 49 states lowered taxes at least once in the last five years with 11 states cutting net taxes in every year of the five.

Tax cuts have been all over the board, ranging from permanent reductions in the personal income tax rate to sales tax exemptions on food. Policymakers have been a little more creative, too. Florida and Texas are celebrating holidays from sales taxes on clothing. Beginning next April, New York will exempt clothing and footwear costing under $110 from its 4 percent sales tax. Taxpayers in Arizona and California will see their auto excise taxes lowered.

Uncertain about the length of the current boom, Connecticut and Minnesota are providing sales tax rebates. The amounts are considerable. Connecticut's $50 rebate for state residents will return almost $100 million to taxpayers. But that amount is dwarfed by Minnesota's plan, which will return $1.3 billion. Rebate checks will range from $212 to as much as $5,186 for taxpayers in the highest tax bracket. The plan also has an interesting twist. Nonresidents who prove they paid Minnesota sales taxes in 1997 can claim rebates, too. Between the sales tax rebate and permanent reductions, Minnesota cut taxes by $2 billion, a staggering 18 percent of prior year collections.

Another angle lawmakers have used is to phase out taxes. Michigan will phase out its single business tax, a substantial state revenue source, over 23 years by dropping the rate by 0.1 of a percentage point each year. Idaho is phasing out about 10 percent of the marriage tax penalty by increasing the standard deduction for married taxpayers filing jointly. Connecticut and Louisiana are phasing out their inheritance taxes.

Phasing out taxes has some big advantages, especially for cautious policymakers who worry that the economy can turn around quickly. Because the reduction is gradual, the amount of revenue lost each year is likely to be modest. Additionally, and perhaps more important, the reduction can be temporarily or permanently halted if the economy takes a nosedive.

These concerns helped guide Michigan's decision to eliminate its single business tax over 23 years. Additionally, a trigger was put into the law that suspends the annual rate reduction if the budget stabilization fund drops below $250 million. "If we're in that bad a shape, we shouldn't be cutting that tax," says Senator Joanne Emmons, who chairs the Senate Finance Committee. "A phased-in tax gives future legislators the opportunity to do something different if they need to."

Some states have taken a slightly different approach - tax reductions are triggered if certain positive economic conditions develop. Ohio's robust revenue growth automatically triggered a 3.6 percent reduction in the income tax rate for 1999. Depending on the amount of excess revenue this year, Arizonans could see $100 million in tax cuts.

SHARE THE WEALTH

Lawmakers have taken advantage of the current boom to fund a backlog of spending needs or to enhance existing programs. But most have resisted the temptation to spend every dime that has found its way into state coffers. That explains why state balances have grown so much over the past few years.

Although many state programs have benefited from the red hot economy, probably none has profited more than public education. States have continued to boost spending on K-12 education in excess of inflation (which, admittedly, has been low) and at a faster rate of growth than other state programs. Much of this additional support has occurred through increases in general purpose aid. But many states also have used excess revenues specifically to boost spending on textbooks, computers, new technology and buildings. Iowa spent $10 million of its extra revenue to fund reductions in class size. Ohio spent $4.6 million on interactive video distance learning. North Carolina used extra revenues to fund the third year of a plan to bring teacher salaries up to the national average.

Higher education, the balance wheel of state finances when times are tough, has made up some lost ground during the current economic expansion. On top of general fund spending increases in line with those for K-12, higher education has benefited from one-time infusions. Indiana used extra funds to establish a community college program. Maine lawmakers funded capital projects for the University of Maine system, particularly the Edmund S. Muskie School of Public Service, and the Maine Technical College system. Vermont provided $6 million for a higher education endowment. Students in Virginia (or at least their parents) are cheering because lawmakers there reduced tuition by 20 percent for resident undergraduates.

There were enough extra funds to go around for many other programs, too. California targeted the maintenance of state parks, increased capitalization of the state infrastructure bank and planned for a new prison. Connecticut and Georgia used extra funds for Year 2000 compliance. Minnesota funded housing and workforce development. New Mexico provided funds for 40 new police officers. Vermont allocated extra funds for low income housing, agriculture, tourism and economic development. In addition to black fly control, West Virginia targeted funds to soil conservation, public broadcasting studio equipment and buildings at the state fairgrounds.

A number of states took advantage of extra revenue to boost balances in their rainy day funds or other reserves. Delaware automatically increased its rainy day fund by $8 million. New Jersey bolstered its fund by $74 million, bringing the total to $608 million. Between the budget stabilization fund and other state reserves, Pennsylvania squirreled away more than $600 million. Using a trigger mechanism, Ohio shored up its fund by $46 million. In total, 17 states tucked money away in reserves.

SOME STATES OUT OF THE PICTURE

But the prosperity sweeping most of the nation has missed a few states. Hawaii's economy has felt the effects of the Asian economic crisis and downturns in construction and financial services. The state is looking at budget cuts in the next biennium.

"The wolf is at the door, and members of the Legislature and the public have got to be aware of it," says House Speaker Calvin K. Y. Say.

Hawaii isn't alone in its fiscal woes. Energy-dependent Alaska is reeling from depressed oil prices and the resulting gaps in its budget. Although the price per barrel of oil has rebounded in recent months, former prices below $10 per barrel put some states in a deep hole. And states without broad-based personal income taxes haven't benefited from Wall Street's astonishing performance and the resulting capital gains realized by investors.

In most states, though, it's hard to imagine a better time to be a legislator. With state revenues rolling in, former budget busters such as Medicaid held in check and state reserves at record levels, what's not to like?

Interestingly, many lawmakers argue that a bounty of riches makes legislating harder, not easier. "Surpluses have the potential to create more problems because there will be 100 ways to spend the money," says Representative John Gard, who co-chairs Wisconsin's Joint Finance Committee.

Representative Paul C. Demakis of Massachusetts has a similar perspective. "When the state is going through good times, more people have more ideas about what to do with the surplus," he says. "And I think the reality is that it creates more conflict and makes it more difficult to achieve compromise and consensus."

Interestingly, Massachusetts and Wisconsin are among four states that missed their budget deadlines this year, demonstrating that healthy finances didn't necessarily make legislative sessions run more smoothly or ensure on-time budgets.

In each of the past several years, a handful of states have started their new fiscal years without budgets. Partisan battles and disputes between the governor and the legislature have been rampant, with bitter disagreements over what to do with surpluses. In some instances, the delay was excruciating. New York missed its March 31 deadline by 126 days and was just hours short of eclipsing the late budget record set in 1997. In Massachusetts, the budget is later than in any year since 1975, when the state was swimming in red ink.

GIVE CREDIT WHERE CREDIT IS DUE

Some observers of state finances might look at current fiscal conditions and argue that the states are merely riding the crest of a national economic boom and that state policymakers don't deserve credit for healthy state finances. But that perspective doesn't give credit where credit is due. Prudent fiscal decisions over the past few years have been instrumental in achieving the states' current fiscal status.

Remembering the national recession of the early 1990s, when revenues failed to materialize as projected, many states have switched to more conservative forecasts in the current economic expansion.

"We went through a period of time in the early 1990s when we experienced serious declines in revenues," says Idaho Senator John Andreason. "Because we're bound by a constitutional requirement to balance the budget, we had to take drastic actions when revenues fell. We want to avoid that kind of fiscal trauma again."

Although this more conservative stance has allowed revenues to pile up, it may have prevented lawmakers from increasing base budgets by amounts that may be unsustainable over the long term. Despite this sense of prudence, almost every state has cut taxes. A sense of caution is evident, though, because many reductions have been modest, phased in, triggered by economic conditions or given as one-time rebates.

Lawmakers also have boosted spending, but many of these increases have been one-time expenditures. During their 1999 legislative sessions, more than a dozen states targeted programs for one-time infusions, a similar number funded one-time capital projects and others reduced debt. These actions mimic what almost every state has done with its surplus revenues in the last few years.

In combination, these decisions demonstrate prudent fiscal management and contribute significantly to the states' current financial health. Although no one has a crystal ball to foretell the next national recession, sound fiscal decisions today could help states weather the next downturn.

"State policymakers have been lucky and good during this expanding economy," says Donald Boyd, director of the Center for the Study of the States at the Rockefeller Institute of Government in Albany, New York. "They will be better positioned to handle the next recession as a result of cautious policies and good fiscal moves."

ANNUAL TAXCUTTERS (Since 1995)

Arizona

California

Delaware

Iowa

Maryland

Massachusetts

New Jersey

New York

Ohio

Rhode Island 

Washington

Corina Eckl heads NCSL's Fiscal Affairs Program. The information for this article was taken from its preliminary report, "State Budget & Tax Actions 1999." The final report will be available in November.