By Sophie Quinton
Grocery, gas and housing prices are going up this year. The stock market is falling. Voters are concerned about the economy, with some analysts warning of a coming recession.
But most state budget analysts aren’t too concerned. Tax collections continue to rise, and states have saved so much money – thanks to economic growth and a flood of federal aid related to the Covid-19 pandemic – that there will be plenty to spend on schools, Medicaid and other services this fiscal year.
Take Arkansas, which has nearly $3 billion in budget reserves thanks to record tax collections last year and this year. That’s about half of what the state spends in a typical year.
Gov. Asa Hutchinson, a Republican, responded to the latest revenue report by calling on lawmakers to return to Little Rock to pass recent tax cuts. The state has so much money that Democrats say lawmakers could employ the August special session to raise teacher pay.
“I think we’re in a budget situation that’s not an either-or solution,” said Senate Minority Leader Keith Ingram, a Democrat. “We can do both.”
Analysts warn that the end of the current boom is near. State economists and budget writers expect revenue growth to leisurely or decline slightly over the next few years. Overall, U.S. economic activity declined in the first quarter of this calendar year, and the Federal Reserve will likely continue to raise interest rates to frosty the economy and lower inflation.
Economists in states like California and New York are watching the stock market because a acute decline in capital gains among the ultra-wealthy could dramatically reduce tax collections. Given the overall economic climate, lawmakers in many states may present more cautious spending plans when they reconvene in the recent year.
In North Carolina, for example, Democratic Gov. Roy Cooper recently approved a budget bill that didn’t include much in the way of recent tax cuts or recent spending because lawmakers feared inflation and a recession. News and Follower in Raleigh reported.
But budget experts say lawmakers don’t need to panic over the overcast economic outlook. The cushion is the money collected in previous years of prosperity.
“State revenues are just starting at a much higher level than before. So there’s room for caution, but not a lot of reason to be afraid,” said Jared Walczak, vice president for state projects at the Center for State Tax Policy at the Tax Foundation, a nonprofit group based in Washington.
“Even if we do see a broader economic downturn, countries are better prepared for it than in previous recessions,” he said.
In the event of a recession, countries have savings that will support them balance their budgets. States will have more than $132 billion at the end of fiscal year 2022, according to a survey by the National Association of State Budget Officials, a professional organization based in Washington, D.C. That’s up from about $77 billion two years ago.
And while inflation will raise state spending, state experts expect these higher costs to be manageable.
Colorado, however, may be an exception. Colorado’s 1992 constitutional amendment, called the Taxpayer Bill of Rights (TABOR), limits state spending increases to the prior year’s inflation rate – defined as the Consumer Price Index (CPI) for the Denver metropolitan area – plus the estimated population in previous year’s raise. This raise is not quick enough to reflect this year’s raise in consumer prices.
“There is essentially a two-year lag between the inflation data that the Constitution requires us to use and the actual prices the state must pay,” said state Sen. Chris Hansen, a Democrat and vice chairman of the Legislature’s Joint Budget Committee.
Hansen said Colorado lawmakers probably won’t be able to raise workers’ wages to keep up with inflation. The same goes for funding other services such as schools and colleges, he said.
“What’s frustrating to me as a budget writer is that at a time when we should have the resources to make the long-term investments voters want, we won’t be able to because of this inflation mismatch.”
He said lawmakers are trying to analyze available options, including exploring whether there is bipartisan support for a ballot initiative to address the problem.
In Pennsylvania, where the state ended the 2021-2022 fiscal year with a significant budget surplus, officials contributed $2.1 billion to the state’s Rainy Day Fund as a cushion for future challenging times.
During a stop in York County earlier this week. Gov. Tom Wolf, a Democrat, acknowledged the arduous economic times facing the state and nation, but noted that the state’s tax collections remain high.
“I track our revenue by category every day,” Wolf said. “And July is now another strong month.”
However, he admitted that “in a market economy there are ups and downs. And eventually the recession will come. We are just not in one,” said Wolf, who will leave office in January 2023 after serving the constitutional maximum of two to four-year terms.
“When will this end?”
State budget writers braced for a severe recession in 2020 after state and local leaders ordered businesses to close and told workers to stay home to leisurely the spread of Covid-19.
However, the economic downturn caused by the pandemic lasted only two months. Since then, tax revenues have been higher than analysts expected. Revenues continue to exceed expectations even as the U.S. economy has begun to leisurely.
Michigan collected more than $1 billion in sales taxes in June, the largest monthly gain in the state’s history, according to Jim Stansell, deputy director and senior economist for the Michigan House Fiscal Agency, which advises the state House of Representatives.
Stansell says Michiganders are complaining about high prices, but they don’t seem to be cutting back on their spending.
“Back in May, we predicted that sales tax would increase by 9.4 percent in FY22,” he said. “We grew by 14.6 percent. It doesn’t look like people are backing down.”
The same applies to corporate income tax, which is levied on corporate profits, Stansell said. Michigan forecasters expected these revenues to raise 7 percent in fiscal 2022. So far, they’re up 21 percent (while most states started fiscal year 2023 on July 1, Michigan will start in October).
“For the last two years we have been asking ourselves, when will this end?” he said.
Government economists and budget analysts generally expect tax revenues to start leveling off this year.
Right now, robust consumer demand is helping to fuel inflation, said David Zin, chief economist for the Michigan Senate Fiscal Agency, which advises the state Senate. Since the beginning of the pandemic, many people have built up savings or paid off debt, thanks in part to federal COVID-19 relief. They spent the extra dollars on everything from houses and cars to vacations.
“If you look at the economy this way, raising interest rates doesn’t even necessarily mean a recession,” Zin said. “This relieves the burden on producers where demand literally outstrips supply.”
Zin said he has talked to manufacturers who have so many backorders that they could continue operating for a year even if they made no recent sales.
Tax revenues also remain high in Colorado across the country. The Colorado Legislative Council, a nonpartisan agency that advises the Legislature, expects the state to raise 22 percent more general funds in fiscal years 2021-2022 than the previous year.
TABOR demands that a immense part of the money be returned to taxpayers. Still, the past few years of growth have created a financial cushion for Colorado, said Greg Sobetski, the council’s chief economist.
He said that if a recession were to come – which his team does not anticipate – “we would be entering a recession from a higher pre-recession peak.”
The inflation paradox
According to the U.S. Bureau of Labor Statistics, the prices consumers face today are about 9 percent higher than they were a year ago.
Rising prices, although painful for consumers, may be beneficial for state revenues.
“A period of high inflation may mean that, at least temporarily, the state treasury will be in a better situation, even if taxpayers or consumers are in a worse situation,” Walczak said.
Higher prices mean higher sales tax revenues, and higher incomes mean higher income tax revenues. Walczak noted that some states do not automatically adjust income tax brackets for inflation.
High oil prices are a boon for countries that tax fossil fuel extraction. Just a month ago, Alaska Department of Revenue officials expected the state to collect $68 million more in fiscal year 2022 and more than $700 million more in fiscal year 2023 than expected.
Since then, oil prices have fallen, disrupting the fiscal 2023 forecast, said Dan Stickel, chief economist at the Alaska Department of Revenue. But the prospects are still quite good.
“We probably have a lower-than-expected surplus at this point, not a deficit,” he said.
Across the country, inflation will also affect government spending on goods and services, but the exact effects are not yet clear.
“We are preparing to begin legislative hearings on the budget beginning July 1, 2023.” said Robert Brech, Arkansas state budget director. “I think there will be more pressure on this budget due to inflation. We just don’t know yet how it’s going to play out.”
For example, lawmakers may face higher prices for infrastructure projects. Colorado Sen. Bob Rankin, a Republican who serves on the Joint Budget Committee, said his committee recently gained insight into how rising construction costs could affect state spending.
Last year, for example, Colorado lawmakers approved $20.6 million for heating, ventilation and air conditioning upgrades at the Auraria Higher Education Center, which houses two public universities and a community college in downtown Denver.
The money was to cover the costs of renovating nine buildings. In June, the center told the Joint Budget Committee that the money would cover the costs of renovating only three of them.
“The first thing I said to myself was, ‘Oh boy, this is what’s coming,’” Rankin said.
Sophie Quinton is a reporter for Stateline, an initiative of the Pew Charitable Trusts, where this story first appeared. Capital-Star staff writer John L. Micek contributed additional reporting.
