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


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.

States Are Starting to Save for Another Rainy Day

April 16, 2014 at 1:19 pm

With the budget challenges of the Great Recession and its aftermath still fresh in their minds, state policymakers are considering ways to strengthen their “rainy day funds” — budget reserves they can use when recessions or other unexpected events cause revenues to fall or spending to rise.  But, it’s still premature for most states to act aggressively to refill the funds until their revenues rise well above pre-recession levels, unemployment has declined further, and they have restored programs cut during the recession, as we explain in a 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.  Since draining reserves to a low of 2.4 percent of spending in state fiscal year 2010, states have begun to refill them partly (see chart).

The decisions about when and how quickly to refill a rainy day fund will be different for each state.  Here are some questions that states should consider:

  • Have tax collections recovered from the recession?  One sign that a state has sufficient funds to begin refilling its rainy day fund is that both its annual tax collections and its annual growth in tax collections have returned to pre-recession levels, after accounting for inflation.  Fewer than half of the states have recovered to this extent.
  • Has the state’s economy recovered?  A return to pre-recession unemployment rates and personal income indicates that the state’s economy is on the mend.  Then the state can more likely meet the needs of its residents and also set funds aside for future downturns.  Most state economies have not yet fully recovered from the downturn.
  • How big is the rainy day fund?  Resuming fund deposits is a higher priority in states with little or no funds remaining.  These states may want to spread the replenishment over more years and should consider beginning sooner.  At the end of fiscal year 2013, 16 states had general fund reserves of less than 5 percent of the budget. 
  • What else might states do with available funds?  A rainy day fund’s ultimate goal is to help maintain state support for education, health care, transportation, and other services that promote economic growth and meet residents’ needs.  If depositing money in the fund would jeopardize a state’s ability to support these programs adequately — especially after years of funding cuts in an economic downturn — program funding should take priority. 
  • Is the state experiencing a revenue “windfall”?  Some states’ revenue collections are temporarily high as a result of a court settlement or other short-term reason.  For example, Connecticut received $175 million this year from a temporary tax amnesty program, and Louisiana is receiving payments from BP as a result of the 2010 oil spill.  States should use caution when deciding how to spend these temporary windfalls.  Shoring up a rainy day fund is a prudent use of one-time funds, while enacting ongoing program expansions or permanent tax cuts could contribute to future budget imbalances.

Click here to read the full paper.

New Report Highlights Need for States to Help Address Income Inequality

March 6, 2014 at 2:05 pm

An important new report documents rising inequality in states across the country.  As we outlined in our 2012 analysis of state-by-state income inequality, states can — and should — take certain steps to help alleviate these trends.

A study of IRS data by the Economic Analysis and Research Network found that:

  • The top 1 percent of taxpayers received the lion’s share of income growth across the country between 1979 and 2007, and its share of income grew in every state.
  • In 15 states, between half and 84 percent of all income growth over this period went to the top 1 percent.  In four states — Alaska, Michigan, Nevada, and Wyoming — incomes grew for only the top 1 percent while the incomes of the bottom 99 percent fell.
  • This lopsided income growth has continued after the recession.  The top 1 percent received at least half of the income growth in 33 states between 2009 and 2011 (the most recent year for which state data are available).

Governments at all levels can take steps to help alleviate these trends.  Specifically, states can:

Stop exacerbating inequality through the tax code.  In most states, low- and middle-income people pay a higher portion of their income in taxes than the wealthy.   States certainly should avoid worsening this trend with tax cuts that benefit the richest households and do little for poor and middle-income families.  For example, cutting progressive taxes like the income tax will benefit high-income families more than low-income families and will widen income gaps further.

Strengthen supports for low-income families.  States play a major role in delivering social safety net assistance.  State assistance with child care, job training, transportation, and health insurance helps poor families get and retain jobs and move up the income scale.  In addition, states can shield the nation’s most vulnerable citizens from poverty’s long-term effects by maintaining their pieces of the safety net.

Raise, and index, the minimum wage.  The purchasing power of the federal minimum wage is 22 percent lower than its late 1960s peak.  Its value falls well short of the amount needed to meet a family’s needs, especially in states with a high cost of living.  Federal action to raise the minimum wage is critical, but states don’t have to wait.  Any state can help raise wages for workers at the bottom by enacting a state minimum wage that is higher than the federal wage and indexing it to ensure continued growth.