The Center's work on 'Taxes' Issues


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.

Child Poverty Remains High, But States Can Make a Difference

September 19, 2014 at 12:55 pm

Update, September 22:  We’ve corrected the map in this post. 

More than half of the states plus the District of Columbia had child poverty rates of 20 percent or higher last year (see map), new data from the Census Bureau’s American Community Survey show, and in some states — like New Mexico and Mississippi — poverty affected as many as one in three kids.  Such extensive child poverty unnecessarily damages the prospects of millions of children.

Relative to their better-off peers, poor children have poorer health, do less well in school, and complete fewer years of education.  Over the long term, they are more likely to have chronic bad health and to work fewer hours and earn less as adults, which can contribute to a vicious cycle of poverty.

In addition, the stress of hunger, unsafe neighborhoods, and unstable housing, among other hardships that many poor families face, can have harmful physiological effects on children’s still-developing brains.  This “toxic stress” can impede their social and emotional development and ability to learn.

States have a range of effective tools to reduce child poverty and the associated hardships. They can, for instance:

  • Raise the state minimum wage in conjunction with creating or improving the state’s earned income tax credit.
  • Provide quality early childhood education to help boost the future prospects of children in poor families while allowing their parents to work and build a better future for them.
  • Connect more poor children to a full range of federal supports, including nutrition, housing, and health care.

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.

Poverty Above Pre-Recession Levels in 47 States, New Census Data Show

September 18, 2014 at 4:46 pm

Poverty remained above pre-recession levels last year in 47 states plus the District of Columbia, our analysis of Census data issued this morning shows (see chart).  In some states, the increase was substantial — in Arizona, California, Florida, Georgia, and Nevada, poverty rates were four to five percentage points higher in 2013 than in 2007.  The stubbornness of high poverty rates in the wake of the Great Recession underscores the need for states to do more to help working families make ends meet.

Poverty rates in the states not still above pre-recession levels, Alaska and the Dakotas, weren’t statistically different from 2007.

Unequal wage growth and rising income inequality have played key roles in preventing more substantial improvements in poverty.  For workers earning low pay, wages are right where they were 40 years ago after adjusting for inflation, according to the Economic Policy Institute.  And since the recession’s official end in 2009, most workers’ wages have fallen, while workers at the top have seen some growth.

States have tools to help to address low wages and rising income inequality.  They can create or improve state earned income tax credits (EITCs), which promote work and reduce poverty and can improve low-income children’s chances of success both in school and, later, in the workforce.  States can also raise their minimum wage — the federal minimum wage is 22 percent below its peak value in 1968, after adjusting for inflation — and index it to inflation.  Improvements in these two areas are complementary for reasons we explain here, reaching a broader population than the EITC or minimum wage alone and keeping many more families out of poverty.

Two Policy Tools States Can Use to Build a Broader Recovery

September 3, 2014 at 3:35 pm

Low-wage workers need a boost.  In the last few years, their wages have fallen sharply and now are no different than they were 40 years ago, adjusted for inflation (see chart), leaving millions struggling to afford basics like decent housing in safe neighborhoods, nutritious food, reliable transportation, and quality child care.  As we detail in a new paper, states can use two effective policy tools to help working families and individuals meet their basic needs and pursue a path to financial stability:  state earned income tax credits (EITCs) and minimum wages.  The two work best when states strengthen them at the same time.

State EITCs and minimum wages help make work pay for families who earn low wages.  They increase income, widen the path out of poverty, and reduce income inequality.  They also help to build a stronger future economy because lifting family income for young, low-income children can result in improved learning and educational attainment and higher future earnings in adulthood.

While each policy is effective in its own right, state EITCs and minimum wages build upon each other’s effectiveness in boosting the prospects of low-wage working families.  State policymakers should improve them in tandem.  Here’s why:

  • State minimum wages and EITCs reach overlapping but different populations.  State EITCs primarily target low-income families with children and are available to working families earning more than three times a full-time minimum wage worker’s annual salary of $14,500.  The minimum wage goes to the very lowest-wage workers, regardless of factors like family income, family status, or age.
  • Increasing both at the same time provides added support to the working families who need it most.  Together, a minimum wage boost and a robust state EITC can move families beyond poverty and further down the road to economic security.  Also, a minimum wage increase provides the added benefit of increasing the EITC for some families.
  • The benefits of the two policies are timed differently.  An expanded minimum wage increases every paycheck, which helps with routine expenses, like food, monthly bills, and rent.  State EITCs are paid at tax time and can be used for larger, one-time expenses, like car repairs or a security deposit.
  • Improving both together allows the public and private sectors to share the cost of boosting incomes for those who work.  The EITC is a cost largely borne by state government, and by extension state taxpayers.  The state minimum wage is borne principally by the private sector, especially employers and consumers.  Improving both policies spreads the cost of making work pay more broadly than does either policy alone.

Many states have increased their minimum wage and a few states have enacted EITC improvements in 2014.  Three states — Maryland, Minnesota, and Rhode Island — and the District of Columbia have done both.  Other states also should look to advance the two policies at the same time to make the biggest impact for families most in need.

Click here to read the full paper.