More About Elizabeth McNichol

Elizabeth McNichol

McNichol is a Senior Fellow specializing in state fiscal issues including methods of examining state budget processes and long-term structural reform of state budget and tax systems.

Full bio and recent public appearances | Research archive at CBPP.org


New Jersey Going from Bad to Worse on Budget Practices

October 7, 2014 at 4:34 pm

New Jersey, which already comes up short in budget planning and budget transparency, is falling even further behind.

The state Treasury Department recently stopped publishing monthly comparisons of actual tax collections to projected collections — information that the state’s revenue status reports had included for years.  The timing is especially unfortunate given New Jersey’s recent large revenue shortfalls.  Delaying acknowledgement of sluggish revenue collections will give policymakers less time to address the problem if these shortfalls continue.

The state has also stopped publishing town-by-town data on state property tax rebates in its annual reports on property tax collections and has removed prior-year reports from its website.  This makes it very difficult to see how state and local policies affect property tax bills across the state.  The state Assembly recently passed, with near unanimous support, a bill requiring publication of the data.  But the bill needs state Senate approval plus the governor’s signature to become law, and Governor Chris Christie hasn’t said if he will sign it.

New Jersey had plenty of room for improvement even before these changes.  It received the second-lowest score in our survey of how well states use ten proven budget planning tools to chart their fiscal course accurately and make mid-course corrections when needed.   It also fared poorly (30th out of 50) in the U.S. Public Interest Research Group’s latest ranking of state budget transparency.

New Jersey should stop digging this hole deeper and resume publication of data that can help the state plan.  And the state should go even further — by including long-term revenue and spending forecasts in its annual budget, building more consensus into its revenue estimating process, and providing more information on the cost of individual “tax expenditures” (tax credits, deductions, and exemptions), for example.

Better budget planning and more transparency would help New Jersey policymakers make more-informed decisions.

Kansas’ Troubles Highlight Need for “Rainy Day” Reserve Fund

September 24, 2014 at 3:45 pm

Kansas these days offers a host of lessons of what not to do when managing state finances.  We’ve already noted one:  don’t enact unaffordable tax cuts.  Kansas’ massive income tax cuts have left it on the verge of a major fiscal emergency, as a Washington Post editorial pointed out.  Here’s another:  don’t go without a formal “rainy day” reserve fund.  Kansas is one of only four states without one, which helps explain its current troubles.

Kansas’ tax cuts caused a revenue decline so severe that the state, in order to pay for this year’s spending, drew on fund balances intended to provide a temporary financial cushion during economic downturns or other unexpected events.  That’s highly imprudent.  When the next downturn hits, Kansas will have little or no cushion to draw on, forcing tax increases or deeper cuts to schools and other public services — on top of the major cuts Kansas imposed due to the recession — when the state economy already is weakened.

If those balances had been held in a well-designed rainy day fund, with specific rules on when the state must make deposits and when (and for what purposes) it can make withdrawals, the fiscal irresponsibility of using these one-time funds to pay for permanent tax cuts would have been more apparent.  Lawmakers might have faced up to the tax cuts’ likely fiscal damage much earlier, by suspending them or even by not enacting them in the first place.

To be sure, Kansas law does require the annual budget to include a cushion equal to 7.5 percent of spending. But that’s not the same as a rainy day fund. Lawmakers have often suspended that requirement in recent years, including this year.  Even when in effect, that cushion is too small; the average state needs a fund of 15 percent or more to weather a moderate recession.

Other states can learn these lessons about reserve funds from the Kansas experience:

  • If you don’t have a rainy day fund, create one.  A rainy day fund moderates the need for large tax increases or spending cuts during economic downturns.  Colorado, Illinois, Kansas, and Montana are the only states without a formal one.
  • Build up reserves in good times.  As the economy slowly recovers from the Great Recession, this is a good time to replenish reserves before the next downturn.  In Kansas, year-end balances grew from 2010 until 2013 but have since plunged as the state drew on them to offset the revenue lost through tax cuts (see chart).  Kansas expects to have a balance near zero by next June (the end of fiscal year 2015) — and, in reality, it likely will reach zero well before then.  This will leave the state unprepared for unanticipated revenue declines or spending increases.  In contrast, states with formal rainy day funds are restocking them.  State year-end balances have doubled since 2010, on average.
  • Use rainy day funds only for temporary, unexpected revenue declines or expenses.  A rainy day fund is designed to fill in short-term budget holes.  Using one-time funds like balances from prior budgets for ongoing spending or tax cuts creates a future imbalance between revenues and spending.  In Kansas, whose tax cuts will permanently reduce state revenues, the current budget is $326 million larger than the state forecasts it will collect in revenues — and the revenue forecast is optimistic, so the real problem likely is even larger.

Why More Inequality Means Less State Revenue — And How States Can Respond

September 19, 2014 at 11:06 am

Growing income inequality in recent decades has slowed state tax collections, a new report from Standard & Poor’s finds, making it harder to fund public services ― like education ― that lay the groundwork for a strong future and help push back against rising inequality. States need to adapt their tax codes to take growing inequality into account.

Virtually all states collect more taxes (as a share of family income) from low- and moderate-income families than from high-income families.  So it makes sense that collections would slow when, as we’ve documented, the lion’s share of income growth goes to the richest families.

  • Many states have a flat-rate or nearly flat-rate income tax.  A flat income tax raises less revenue from economic growth — especially when most of the gains go to people at the top of the income scale — than a graduated income tax, which taxes higher incomes at higher rates.
  • Growth in sales tax collections weakens when low- and middle-income families’ incomes stagnate or grow more slowly, since they spend (rather than save) a larger share of their income than wealthy families do.
  • States’ antiquated sales tax rules favor high-income consumers.  Those at the top tend to spend more on services, like lawn care or health club memberships, which remain exempt from sales tax in many states.  They also spend a larger share of their income online — purchases that often are effectively tax-free.

States can respond to slowing tax collections by making their income tax more progressive through a more graduated rate structure.  This would make tax collections more responsive to economic growth, bringing faster revenue growth when the economy expands.  Tax collections would also fall more when the economy slows, but states can address this with stronger reserve funds, better mechanisms to manage surpluses, and other policy tools, as we have explained.

States also can broaden their sales tax base to include more services, including those used by high-income families, and extend the sales tax to Internet sales.

Over time, these changes would give states more resources to push back against rising inequality by investing in education and training, providing supports like child care assistance for low-wage workers, and adopting or expanding state earned income tax credits.

Conversely, if states fail to adapt their tax systems to this growing problem, they will have an even harder time stemming the harmful rise in inequality.

Five Ways That States Can Produce a More Trusted and Reliable Revenue Estimate

August 7, 2014 at 12:10 pm

Update, September 4: We have updated this post to reflect updates in the related revenue estimating paper.

Every state estimates how much revenue it will collect in the upcoming fiscal year. A reliable estimate is essential to building a fiscally responsible budget and sets a benchmark for how much funding the state can provide to schools and other public services. Yet, as our new report highlights, some states forecast revenues using faulty processes that leave out key players and lack transparency.

While there is no one right way to forecast revenues, research and experience suggest that states benefit from the following common-sense practices.

  • The governor and legislature should jointly produce a “consensus” revenue estimate.  More than half the states (28) employ such a “consensus” process.  In the other 22 states and the District of Columbia, either the governor and legislature produce competing forecasts (a recipe for gridlock and political infighting) or one branch of government is left out of the official process, which may reduce the revenue estimate’s value as a trusted starting point for writing the state budget.
  • The forecasting body should include outside experts.  Including experts from academia or business, along with economic and budgeting experts from within the government, widens the economic knowledge available to the forecasting body and can improve how well a forecast is trusted.  While more than two-thirds of the states draw on outside experts, 15 states do not.
  • The forecast and its assumptions should be published and easily accessible on the Internet.  Most states follow this practice, but six do not, leaving their estimates less transparent to anyone who is not directly involved in the forecasting process.
  • Meetings of the forecasting body should be open to the public.  In 20 states and the District of Columbia, forecasting meetings are closed to the public, unnecessarily diminishing the trust with which the forecasts might otherwise engender.
  • Estimates should be revised during the budget session.  Reviewing earlier estimates to adjust them for changing economic circumstances can improve their accuracy.  Eleven states do not regularly review their estimates and release a revised forecast during the course of the budget session.

Together, these components create a strong, reliable revenue estimate. For example, a professional and open revenue estimating process makes revenue forecasts more transparent and accessible to the public and a broader group of legislators, which can lead to a healthier and more democratic debate and greater fiscal discipline.

States wishing to improve their revenue estimating practices have a number of models, since many states have adopted practices that produce a more trusted forecast (see map).  Fifteen states employ all five of the best practices identified by our research and can serve as models for the rest of the country.  Eleven states employ only one or twoof the five best practices.  These states, in particular, could benefit from adopting the better revenue estimating practices that many other states use.

Click here for the full report.

3 Steps States Can Take to Improve Their Rainy Day Funds Now

April 21, 2014 at 10:02 am

States can take concrete steps now to improve the structure of their rainy day funds, helping them to more effectively weather the impact of inevitable future downturns, as we explain in our new paper.

States used their rainy day funds to avert over $20 billion in cuts to services, tax increases, or both, in each of the last two recessions, highlighting the funds’ importance.  Yet these reserves filled only a modest share of states’ record-setting budget gaps; states would have weathered the storms better with bigger rainy day funds.

States shouldn’t make rapid replenishment of rainy day funds a priority until their revenues rise well above pre-recession levels, unemployment has declined further, and they have restored programs cut during the recession — and most states are not yet there.

But, when they are ready to replenish those funds, here are three steps they can take:

  1. Create a rainy day fund, if they don’t have one.  Four states — Colorado, Illinois, Kansas, and Montana — lack a designated rainy day fund.  The budgets of all of these states except Montana were hit hard by the economic downturn, and the lack of a rainy day fund left them more vulnerable to the recession’s effects.
  2. Loosen overly restrictive caps on the size of rainy day funds.  One reason rainy day funds weren’t even more effective in the most recent downturn is that 31 states and the District of Columbia cap them at inadequate levels, such as 10 percent of the budget or less.  States with overly restrictive caps could either remove the cap or raise it to a more adequate level, such as 15 percent of the budget.
  3. Ease rainy day fund rules that make it difficult to make deposits in good times.  Most states place a low priority on replenishing their funds, depositing only whatever surpluses are left over at the end of the year.  States could integrate rainy day fund transfers into the budget as part of an overall reserve policy that places a high priority on saving.

Click here to read the full paper.