Modest Revenue Growth, Depressed Income Tax Collections Pose Fiscal Challenges for States in FY15

Two recent reports highlight volatile state fiscal conditions on the revenue and spending side of state budgets. Preliminary data for April 2014 show large and widespread declines in overall personal income tax revenues, thus creating challenges for many states with resulting shortfalls, particularly those that rely most heavily on personal income taxes, according to a state revenue special report from the Nelson A. Rockefeller Institute of Government. Meanwhile, on the spending side of state budgets, NASBO’s latest Fiscal Survey of States reports increased spending in 42 states, which is attributed mainly to K-12 education and Medicaid. 

While the declines in personal income tax collections were anticipated, the size of the declines surprised officials in many states, according to the authors of the state revenue special report. Referred to as the April “surprise,” the depressed income tax collections seemed to have been driven by taxpayers who shifted income from tax year 2013 to tax year 2012 to minimize federal tax liability resulting from the “fiscal cliff.” April collections represented the bulk of the decline, with states collecting $7.9 billion less compared to the same month last year. Total personal income tax collections in January-April 2014 were 7.1 percent, or about $8.4 billion below the level reported a year ago. Stats were collected from 38 of 41 states that have a broad-based personal income tax.

The authors note that while the sharp declines do not signal a fundamental weakening in the economy, the state budget processes in many states could be negatively impacted. For states without large cash balances, the timing of the shortfall may cause a cash flow crunch or crisis. Other states may find themselves facing a “double whammy” effect. That is, states with revenue shortfalls in 2014 generally will reduce forecasts for 2015 as well. Finally, negotiating ways to close new budget gaps may become more difficult because the shortfall came late in the fiscal year and in the budget process, according to the authors.

States are expected to bring in more revenue in FY15 than the prior year; however, spending also is up in 42 states, based on governors’ recommended budgets. The NASBO report finds state fiscal conditions have reached greater stability following consistent year-over-year growth, but progress remains slow with continued budgetary constraints expected to last into the next fiscal year. Most governors proposed no tax changes or relatively modest changes in FY15. Governors in 15 states proposed tax decreases. The report notes that FY15 is the first time since the onset of the recession that governors put forth recommendations to reduce rather than increase net taxes and fees.