The Center's work on 'Taxes' Issues


Why Money Doesn’t Walk

October 20, 2014 at 11:24 am

We’ve shown that interstate differences in tax levels have little effect on whether and where people move, contrary to claims by some tax-cut proponents.  The related claim — that people who leave a state take their incomes with them, harming that state’s economy — isn’t true either, our new paper explains.

The vast majority of people can’t take their income with them to a new state because they work for someone else.  When people leave a state, they usually also leave their job.  The income they made in that job then typically goes to the person who gets that job next; it doesn’t leave the state.

For example, consider a California sales representative who is transferred to Nevada.  What you might call “income migration” (or “money walks”) analyses would suggest that California’s economy is weakened because the sales representative moved away and took her income with her.  In reality, her income stayed with her employer and was then transferred to her replacement.  California’s economy was not harmed.

Income migration analyses also ignore the income gains for other in-state small businesses when business owners move away.  For example, if a New York doctor in private practice retires and moves to Florida, his or her patients ― and their payments ― will go to some other New York provider, increasing that provider’s income.  Also, the owner of a successful business who leaves will often sell it to someone who will continue to operate it.

Moreover, income migration analyses effectively assume that people’s incomes stay the same after they leave a state, even if they don’t find a job in the new location or moved there to retire.  That assumption further skews their results.  For example, when someone from New Jersey retires to Florida, income migration analyses claim that New Jersey’s economy lost income equal to the person’s pre-retirement salary, even though that person’s income probably would have declined even if he or she had stayed in New Jersey.

To be sure, some income does automatically follow a person when he or she leaves a state — pensions, Social Security, and investment earnings, for example.  But that represents a relatively small share of total taxable income — under one-fifth in most states.  And, as with other forms of income, much of such income that is “lost” to a state when people move out is replaced by income “gained” when others move in.

Policymakers should focus their attention on the policy choices most likely to grow the incomes of their current and future residents, and not be distracted by misleading claims about income migration.  The chief policy prescription that the income migration concept is used to justify — deep cuts in (or outright repeal of) state income taxes — would likely prove self-defeating, leading to deteriorating schools, roads, public safety, and other services that make states places where businesses want to invest and where the engineers, managers, and other personnel they need to hire want to live.

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.

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.