July 20, 2014
State Taxes and a Slowing Economy
The last couple weeks brought to a close the fiscal year for most state and municipal governments. This is a time to assess the condition of tax revenues and a time for states like Indiana that operate on a two-year budget to consider adjustments. It is also a time for economists to puzzle over the tax figures and try to understand the current state of the economy.
State income taxes are a good place to try to begin understanding state economic performance because personal income is very sensitive to changes in the economy. Moreover, the process of withholding our estimated tax liability from our paychecks makes income tax revenues a good early predictor of the state of the overall economy. The past year tells an ominous story.
Nationally, from July through September 2013, growth in state income tax collections slowed appreciably. Only a few states were spared that slowing, and here in Indiana they actually shrank slightly as they did in five other states. Much of that shrinkage could be attributable to the budget deal of 2013, which eliminated a payroll tax cut of 2 percent and raised tax rates on high-income earners. This reduced taxable income and slowed the growth of economic activity enough to explain some, but certainly not all, of these declines. This trend continued into forth quarter 2013, with overall slowing pushing 11 states in the full red, with revenues below that of the previous year. Six states, including Indiana, cut the budget at the year’s end. All of this is an early warning signal of a slowing economy.
The first quarter of this year was a fiscal disaster with only four states seeing positive growth in personal income taxes. Some of this could be attributed to a quarter in which the U.S economy shrank at a recessionary pace. The winter was harsh after all, and certainly impacted the economy in many places. The problem is that the April revenues were much worse, and the expected rebound that should have accompanied the improvement in the weather, failed to materialize. In fact, April’s losses were worse than the January-March income tax declines across the U.S. While the loses to places which suffered a difficult winter were bad, the largest gap between the January through March income tax revenues and that of April was in the desert southwest whose winter could scarcely have had much of an impact on economic activity.
Some of the changes could be the result of lingering adjustment to the 2013 budget deal, and the impact of income tax reductions or more minor rule changes in a dozen states. But these changes and weather cannot, in my judgment explain half the decline in tax revenues, and probably much less. Something else is going on in our economy.
Virtually no residential construction jobs were created in May and June, signaling a stalled housing market and perhaps a broader weakness in the economy. For most states, including Indiana, this means more belt-tightening awaits us in 2015.
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