The era of federal red ink is back with vengeance. Let’s review the numbers: In President Bush’s first budget, the administration forecast a cumulative surplus of some $1.6 trillion in fiscal years 2004 to 2008. Now, driven by large tax cuts and massive increases in defense spending, the Administration predicts a total deficit of more than $1 trillion over the next five years-and that prognosis doesn’t include the cost of war with Iraq.
It’s not just the federal government that’s spilling red ink. State budget gaps have increased by 50% over the past two months. Yet, unlike the federal government, states can’t run deficits. State budget shortfalls must be closed.
The easy remedies are exhausted. State governments have borrowed, drawn down reserves, and tapped into tobacco settlement money. Now, from California to Minnesota to New York, states are focusing on slashing spending to balance the books. A handful of states will raise revenue by hiking taxes or fees.
No one is happy. Policymakers and voters are upset at proposals to cut infrastructure projects, job training programs, early childhood education, and other valuable programs. The fragile economy is also taking a hit from cutbacks at the state level.
To be sure, state finances will improve once the economy perks up. Yet the underlying problem will persist. The tax base has been eroding over the past two decades. Meanwhile, the cost of providing labor-intensive state services, such as social services and education, is rising fast.
Take the sales tax. It has been worn down by exclusions, the exemption of services, and the rise of mostly untaxed electronic commerce. The state income tax, the major source of state revenue, is volatile. State coffers swelled during the 1990s as companies paid employees stock options and bonuses, and investors cashed in their gains during the bull market. But when the stock market tanked, so did taxable realized capital gains and revenue collections.
There’s got to be a better way. Right now, almost all of the focus is on the expenditure side of the ledger. But the key to more stable state finances lies with fundamental tax reform. Among the more intriguing proposals: Get rid of all the different state taxes and recipes for raising revenue; instead, states should adopt one or more common taxes and then share the revenues on a formula basis.
Calls for reform when times are tough sounds quixotic. But it’s when budgets are under pressure that policymakers are more open to radical alternatives. The states should start working toward an overhaul of the state taxing system.
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