Off the Charts Blog | Center on Budget and Policy Priorities

North Carolina’s Senate yesterday passed a budget that undermines key services, including education.  This is one more step in the wrong direction for the state’s policymakers, who have spent this legislative session debating how much to cut taxes for the wealthy, how much to raise taxes on everyone else, and how massive a hole to blow in the state’s funding for schools and other services.

Under the banner of tax reform, both the House and Senate have proposed plans that center around a massive income tax cut that would mainly benefit the rich and corporations.  They’d pay for the cut, in part, with a sales tax expansion that would make the overall state tax bill fall more heavily on low- and middle-income households.  This tax shift would further exacerbate inequality in a state that already has a wide gap between the rich and the rest.  For example, poor and middle-class North Carolinians saw their incomes drop between the late 1990s and mid-2000s, while upper-class household incomes rose (see chart).

These plans come with hefty price tags.  In addition to raising taxes on low- and middle-income households, the Senate’s tax plan would open up a new budget shortfall of over $1 billion within three years.  The House plan would produce a $1.2 billion shortfall over five years.  That means that key services will take a hit.

Indeed, the Senate’s budget eliminates class size limits for grades K-3, lays off teachers, and cuts thousands of pre-k slots available to at-risk children.  This would occur in a state that over the course of the recession cut its per-student funding for K-12 education 14 percent below pre-recession levels, after adjusting for inflation.  The state also cut its higher education support per student by 15 percent over that time.  As a result, tuition at the state’s public four-year universities has jumped an average of 31 percent per student.

The harmful tax and spending ideas don’t stop there.  The legislature also is looking to eliminate the state’s estate tax — a tax that just 23 of the wealthiest estates paid in 2011 — after slashing benefits for unemployed workers and enacting legislation that scraps the state’s Earned Income Tax Credit, which helps working families with children get on a path to the middle class.

How did the legislature win public support for raising taxes on low- and middle-income households while cutting taxes for the rich and undercutting services that residents and businesses want and need?  Well, they didn’t.  A recent poll shows a large majority oppose the details of the Senate and House tax plans.

As states finalize their budgets for the next fiscal year, Minnesota stands out for making smart changes to its tax system that will position the state for future economic growth.  The legislature passed a tax plan last night that — after years of spending cuts — raises revenue to avoid more cuts and to make new investments that brighten the state’s economic future.  It also modernizes the state’s tax system so that it generates adequate revenue for a thriving state in a 21^st century economy.  Governor Mark Dayton supports the legislation and is expected to sign it.

The plan creates a new income tax bracket for the state’s richest households, repeals some tax breaks for companies operating outside the United States, raises revenues through changes to estate and gift taxes, and increases tobacco taxes.  It also helps modernize the state’s outdated sales tax system, including by taxing some digital goods and by requiring some online retailers to collect sales taxes on purchases by Minnesota residents.

The new revenue will prevent more than $600 million in cuts over the next two years to services such as schools, community colleges, natural resource protection, and programs that help seniors live independent lives.

The revenue also will enable the state to make substantial new investments in education.  For example, Minnesota will provide free full-day kindergarten in more public schools across the state, and it will substantially improve access to high-quality preschool for underprivileged children — an investment that research has proven boosts the incomes and productivity of children when they grow up.

Among other priorities, the plan also will allow the state to hold tuition steady in the state’s colleges and universities, and to increase financial aid for low- and middle-income families.  Over the last five years, Minnesota has cut funding for higher education by 30 percent, leading to substantial tuition hikes.

These investments in the state’s education system will pay off with stronger economic growth in the future by producing a better educated workforce with the kinds of skills and training that employers — especially high-wage employers — will need in the future.

The new revenue also will allow the state to reduce property taxes for many homeowners and many low- and moderate-income renters, who pay property taxes through their rent.  And, it will allow for more state aid to local governments, helping them further limit property taxes.  These substantial reductions in property taxes, combined with the income tax increase for wealthy residents, will make the state’s currently regressive state and local tax system fairer.

States that are still considering tax and spending changes — and how to boost their economies while supporting middle- and lower-income families — should look carefully at Minnesota’s plan.

To accompany our Top 10 Federal Tax Charts, here are five charts focusing on state tax issues.

First, let’s look at what state taxes pay for.  By far the largest areas of state spending, on average, are education (both K-12 and higher education) and health care, as the first chart, below, shows.

But states also fund a wide variety of other services, including transportation, corrections, pension and health benefits for public employees, care for persons with mental illness and developmental disabilities, assistance to low-income families, economic development, environmental projects, state police, parks and recreation, housing, and aid to local governments.

The second chart, below, shows that state tax revenues fell sharply during the Great Recession and still haven’t fully recovered. Nationally, revenues remain 5 percent below pre-recession (fiscal year 2008) levels, after adjusting for inflation.  Until revenues have recovered further, new tax cuts — which several states are considering — would make it difficult to fund education, health care, and other programs.

Every state taxes middle- and low-income families more than wealthy families, according to a recent report from the Institute on Taxation and Economic Policy (ITEP), on which the third chart, below, is based.  This is one reason why recent proposals in some states to swap their income taxes for sales taxes would be ill-advised.  Those proposals would only worsen tax systems that are already highly regressive.

Cutting or eliminating state income taxes is also a poor strategy for promoting economic growth.  As the fourth chart, below, shows, the five states that enacted the deepest tax cuts during the boom years of the middle and late 1990s saw job growth over the next full economic cycle (2000-2007) of less than 0.3 percent per year, on average, compared to 1.0 percent for the other states.  They also had slower income growth than the rest of the nation on average.

One of the most common arguments for income tax cuts is that they’d encourage small businesses to grow and create jobs, since most small firms pay taxes on their profits under the personal income tax.  But, as the fifth chart shows, personal income tax cuts are a very poor way to stimulate job creation among small businesses:  only 2.7 percent of personal income taxpayers own a bona fide small business with any employees other than the owner or owners, according to a Treasury Department study.

As Tax Day approaches, we’ve updated three backgrounders that explain the sources of federal tax revenues and how we spend both federal and state tax dollars.

Where Do Federal Tax Revenues Come From?

In fiscal year 2012, the federal government spent $3.5 trillion on the services it provides.  Of that $3.5 trillion, federal revenues financed close to $2.5 trillion. The remaining amount (about $1.1 trillion) was financed by borrowing; this deficit will ultimately be paid for by future taxpayers.

The three main sources of federal tax revenue are individual income taxes, payroll taxes, and corporate income taxes; other sources of tax revenue include excise taxes, the estate tax, and other taxes and fees (see chart).

Where Do Our Federal Tax Dollars Go?

In 2012, about three-fifths of federal expenditures went to three areas:  defense and international security assistance, Social Security, and the major health insurance programs (Medicare, Medicaid, and the Children’s Health Insurance Program).  Two other categories together — safety net programs and interest on the federal debt —accounted for another fifth of federal spending.  The remaining fifth of federal spending supported a wide variety of other public services, including providing health care and other benefits to veterans and retirement benefits to retired federal employees, assuring safe food and drugs, protecting the environment, and investing in education, scientific and medical research, and basic infrastructure such as roads, bridges, and airports.

Where Do Our State Tax Dollars Go?

By far the largest areas of state spending, on average, are education (both K-12 and higher education) and health care.  But states also fund a wide variety of other services, including transportation, corrections, pension and health benefits for public employees, care for persons with mental illness and developmental disabilities, assistance to low-income families, economic development, environmental projects, state police, parks and recreation, housing, and aid to local governments.

Click here for the backgrounder on where our federal tax dollars come from, here for the backgrounder on where our federal tax dollars go, and here for the backgrounder on where our state tax dollars go.

In delivering the Republican Party’s weekly address on Saturday, Kansas Governor Sam Brownback made the rosy claim that states can cut taxes deeply without hurting their schools and other investments in the future, and he used his state as an example.  But the governor’s claim is too good to be true — and his own state proves it.

Governor Brownback claimed that he’s turned the state’s budget deficit into a surplus, even while passing the largest tax cut in Kansas history.  “To make that financial turnaround a reality,” the Governor claimed, “. . . we didn’t cut state funding to schools.  We didn’t cut state funding for our universities and colleges.”

In fact, state funding for general elementary and secondary education is lower, even in nominal terms, than when Brownback took office in 2011, and is down sharply — by 10 percent — after adjusting for enrollment growth and inflation.  Higher education funding is up slightly in nominal terms, but down 4 percent after adjusting for enrollment growth and inflation.

Further, Brownback’s claim ignores his decision to lock in education funding cuts enacted earlier in the recession, before he took office.  Since 2008, per-student K-12 education funding is down 14 percent after adjusting for inflation, and will be down 19 percent by 2015 if the Governor gets his way (see chart).  In addition, per-student higher education funding is already down 24.5 percent.

Funding for education in Kansas will likely continue to decline, thanks to the massive income tax cut that Governor Brownback signed last year.  That tax cut, which slashed taxes for the wealthy and profitable corporations while raising them for low-income seniors and families, drained $700 million from the resources available to fund education and other services.  The legislature’s research arm says that, starting in 2014 as a result of the tax cut, revenues will fall far short of what it would cost to maintain funding for schools and other state services at current levels ― levels that already reflect the aforementioned cuts in funding for K-12 schools and for higher education.

Despite proposing to raise other taxes to offset the impact of last year’s tax cut and help balance the budget, Governor Brownback proposes cutting per-student K-12 school funding by about another 5 percent by 2015, after adjusting for inflation.  He also has called for gradually eliminating income taxes altogether, without explaining how Kansas could afford to do so.

Citing the budgetary damage from the tax cuts, a state district court found in January that Kansas is unconstitutionally underfunding its elementary and secondary schools.

Contrary to his claims, Governor Brownback’s own experience shows that states can’t slash taxes without damaging funding for fundamental state services.  There’s no free lunch.