States Likely To Raise Taxes, Fees
Cigarette, fuel, vehicle licensing could lead the way

May 16, 2002

By Russell Gold
THE WALL STREET JOURNAL

— Faced with deteriorating budgets that show few signs of recovery, states are expected to raise taxes and fees a combined $2.4 billion in the fiscal year beginning July 1, reversing an eight-year run of cuts. And that’s just the tip of the iceberg.

 CALCULATED WITHOUT factoring in an increase in California so big that the estimate could almost double, the rise, although only 0.5% of state revenues, would nonetheless unravel a solid 7.2% of the tax-and-fee cuts achieved since 1994.
 For now, most of the revenue increases are expected through higher fees as well as larger cigarette and motor-fuel taxes, according to a report to be released Thursday by the National Governors Association and the National Association of State Budget Officers.
 But states are reporting that personal-income-tax refunds were up an unexpected 10.6% in April, partly because a sluggish stock market reduced taxpayers’ capital-gains income. That is causing preliminary revenue forecasts to appear overly optimistic and is expected to lead to further tax increases as governors face larger-than-expected deficits.
 Already, California Gov. Gray Davis announced this week a proposed increase of $2.03 billion in new taxes and fees, including raising the cigarette tax by 50 cents a pack and nearly doubling the state vehicle-licensing fee. These aren’t included in the proposed increases estimated in the report to be issued Thursday.
 The report also finds that states expect a 1.4% nominal increase in state spending, the slowest rate of growth since 1983 and far below the 5.5% average over the past decade. The combination of that slowdown with the new taxes, which will decrease consumers’ spending power, “is clearly a drag on the economy,” says Ray Scheppach, executive director of the National Governors Association.
 Mr. Scheppach hopes the federal government, which unlike the states isn’t constitutionally required to balance its budget, will help the states avoid further spending cuts or tax increases.
 In the U.S. Senate, Maine Republican Susan Collins and Nebraska Democrat Ben Nelson are expected to introduce a federal relief package for the states in the next few days. The package includes $4.6 billion in block grants for health care and social services as well $4.3 billion in additional Medicaid funds. Spending on Medicaid, a joint federal and state health-care program for the poor and disabled, grew 13.4% in fiscal 2002, which began in July. (A majority of states operate on a fiscal year that begins July 1.)

 During the early stages of an economic downturn, state and local governments tend to provide a counter-cyclical boost as states spend down their “rainy day” or reserve funds and avoid widespread spending cuts or tax boosts. But that boost-estimated to add between 0.3 and 0.6 percentage point to the real gross domestic product-is disappearing, says Goldman Sachs senior economist Ed McKelvey. He expects states to rely mostly on increases to tobacco taxes, rather than sales or personal-income taxes, at least through the fall elections, when 36 states will elect a governor. “If there is tax pain, a lot of the high-profile stuff will be done after November,” he says.
 Already, this state-budget crunch appears worse than during the early ’90s downturn, and Mr. Scheppach expects it to last another 12 to 18 months. In fiscal 1992, state-budget shortfalls were 6.2% of general revenue; 10 years later, the shortfalls are 7.8% of general revenue.

 What’s more, states face emerging structural budget problems masked by the economic boom of the mid- to late-1990s, when they were able to generously cut taxes and expand services. These structural problems include the erosion of the state sales-tax base, because the booming service sector and online sales are largely exempt from sales taxes. “Even when the economy recovers,” says Mr. Scheppach, “it’s not going to get a lot better for the states because of the combination of the eroding tax base and the exploding cost of health care.”
 
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