States still in good fiscal shape despite revenues drop

Inflation-adjusted revenues of the 50 states were down 13.7% January through August compared to the same period a year earlier, the Urban Institute reported, but despite this states remain fiscally healthy, thanks to prudent use of recent surpluses, one analyst said.

In nominal terms, revenues were down 9.7% in the period.

August state tax revenues increased 0.9% in nominal terms but declined 2.7% in inflation-adjusted terms year-over-year, UI said. The median state experienced a 4.7% decline in tax revenues in inflation-adjusted terms. 

During the January to August period inflation-adjusted personal income tax revenue fell 24%, corporate income tax revenue fell 18%, and sales tax revenue fell 1% compared to a year earlier, UI said.

“The decline in income tax revenues is largely attributable to stock market volatility and state income tax rate cuts,” said UI Principal Research Associate Lucy Dadayan. “Meanwhile, the weakness in sales tax revenues is attributable to shifting consumer patterns away from taxable goods and a decrease in overall consumption.”

The data isn’t surprising, said Eric Kim, head of U.S. State Ratings at Fitch Ratings. Sales taxes and personal income tax withholding were up nominally in August from a year earlier, which indicate continued U.S. economic strength.

Forty-six states have stable outlooks from Fitch and four have positive outlooks.

States have been prudent with surpluses tin the last few years, Kim said, often paying down debt and increasing reserves. This has generally left them in good positions.

According to the National Association of State Budget Officers, total state reserve balance as a percent of general fund expenditures was 35% last year, compared to roughly 6% in 2012.

States expect revenues to slow and have generally budgeted accordingly, Kim said.

In recent months several states have passed major tax cuts. Fitch is keeping an eye on how they are implemented and how they affect revenues, Kim said.

Despite the fiscal health, inflation has impacted states, Kim said. Capital projects have been the biggest problem, with many costs coming in higher than projections. While state workers have received salary increases, this has not posed as big an issue on budgets as the extra costs of capital projects. On the positive side, health care cost increases have been manageable.

States should have a plan to “slow or reverse approved tax cuts” should budgets “become structurally unbalanced and now ample ‘rainy day’ funds [become] depleted,” said Evercore Director of Municipal Bond Research Howard Cure.

“States should also be mindful of some recent recurring costs that have become increasingly burdensome,” Cure added. “This could include addressing learning loss in K-12 schools post-pandemic, the migrant crisis, and the need for affordable housing. These trends are occurring all without the expectation of additional federal aid.”

States that implemented tax rate cuts could “face impending fiscal challenges,” Dadayan said. While surpluses and better funded rainy-day funds will help states, “those resources are finite, forcing states to again grapple with the need for raising more revenues or enacting spending cuts in the years ahead.”