Revenue boom should pave way for tax cuts

USA Today (Society for the Advancement of Education), April, 2006

The nation's strong economic growth is creating a revenue boom for state and local governments, as tax revenues soared 8.1% in 2004 and 7.6% in 2005. State taxes increased 8.7% in 2004 and 8.1% in 2005. Local taxes jumped 7.3% in 2004 and 7.1% in 2005.

At the local level, taxes have been rising rapidly for years. As property values soar, cities and counties receive a windfall because they derive about three-quarters of their tax revenues from property tariffs.

At the state level, the economic downturn earlier this decade caused revenue growth to slow and briefly turn negative. However, the "crisis" that states complained about was exaggerated--and now is long gone. By 2005, tax revenues for the 50 states were up 18% over the prerecession peak of 2001. Also note that Federal aid to the states has grown at more than seven percent annually since 2000.

With today's rising revenues, states that had increased taxes to fill gaps can return the money to taxpayers now that budgets are in surplus, according to Chris Edwards, director of Tax Policy Studies at the Cato Institute, Washington, D.C. The 50 states enacted net tax increases of $24,000,000,000 during the past five years, but now they can reverse course and provide major tax relief.

However, some states are using the revenue boom to expand their budgets beyond sustainable levels, as many did during the 1990s. In California, Gov. Arnold Schwarzenegger has proposed a general fund budget increase for Fiscal Year 2007 of 8.4%, which follows a 9.7% increase for 2006. In Maryland, Gov. Robert Ehrlich has suggested a general fund (apart from reserve fund) increase for Fiscal 2007 of 11.4%, which follows a 7.6% increase for 2006.

Total tax revenue for the 50 states and the District of Columbia between 2002-05 increased 22%. The fastest growth was in Alaska, Wyoming, Nevada, Florida, South Carolina, Vermont, and D.C. Overall burdens of state and local taxes as a percentage of personal income is up as well. The U.S. average is 10.5%.

States that combine high income tax rates with high overall tax burdens include California, Louisiana, Maine, Minnesota, Nebraska, New Jersey, New Mexico, New York, Ohio, Rhode Island, Vermont, West Virginia, and Wisconsin. All those jurisdictions are ripe candidates for tax relief in 2006.

The most important goal of tax reform is te cut top income tax rates. In today's competitive economy, capital, skilled labor, and retirees are increasingly mobile and will gravitate to lower-tax jurisdictions. With the coming retirement of the large baby-boom generation, high-tax states such as New York will shoot themselves in the foot if their policies prompt retirees to pull up stakes and head to sunny and low-tax locations such as Florida.

High corporate income taxes similarly are counterproductive. State corporate taxes have a high ratio of compliance costs to revenue collected, and they induce businesses to shift real investments and paper profits to low-tax states and foreign countries. Competition for jobs and investment only will increase in the years ahead. By restraining spending and pursuing tax reforms, states will be better prepared for the next downturn and better able to sustain long-run growth, concludes Edwards.