States May Be Jumping The Gun By Cutting Taxes

It's hardly a dramatic change, but there's no question that the budgetary outlooks of the nation's state and local governments are starting to brighten. In most states and some cities, the strengthening economy is finally producing enough tax revenues to ease fiscal pressures a bit.

Economist Steven D. Gold at the Center for the Study of the States in Albany, N.Y., estimates that state tax revenues nationwide were up a healthy 5.1% in the first quarter over their year-earlier level, and unlike former years, that's without the help of big tax hikes. The upswing has encouraged the governors of at least 19 states to propose tax cuts this year. Four of these states--Arizona, Georgia, New Jersey, and New Mexico--have already enacted such cuts.

To a large extent, the rash of tax-cut initiatives is a cyclical phenomenon. States typically boost taxes heavily during fiscal emergencies caused by recessions and then, as they did during the 1980s, roll back all or part of the hikes once the economy recovers and tax receipts pick up steam.

What's different in this cycle, however, is the fiscal backdrop. When the economy took off after the 1981-82 recession, the combined balance of all state and local operating budgets (including capital outlays) moved into the black (chart). This time around, the operating balance has remained heavily in the red. And the proposed net reduction in fiscal 1995 taxes would slice only 0.03% from projected state revenues, or a paltry $1.3 billion, compared with tax hikes of $31 billion over the past four years.

Gold says he spies another cyclical influence in the current outbreak of tax-cut fever--the electoral cycle. Some 10 governors advocating tax cuts this year are up for reelection in the fall, he notes, and "tax cuts are a proven vote-getter." He also predicts that the cuts will put even more pressure on hard-pressed localities, whose taxes have been rising even faster than state levies, as state aid to local governments has slowed.

Although some governors, mainly Republicans, are trying to use tax cuts as a lever to force cuts in state and local spending, economist Cynthia M. Latta of DRI/McGraw-Hill doubts that overall outlays can slow or that operating deficits will decline over the next few years. She points to rising Medicaid outlays, growing pressure to strengthen the criminal justice system--last year 40 states were under court order to improve prison conditions--and expanding educational needs.

Elementary and secondary school enrollments, for example, are now rising by 1.5% to 1.7% a year after falling in the early 1980s and growing slightly in the late 1980s. And real outlays per student have jumped by 11% since 1987.

"Eventually, spending will slow," says Latta, "but it won't be tomorrow."

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