WACO, Texas – Although the economy is finally almost back to where it stood before the recent recession by some measures, other indicators remain depressingly off.

Job gains have been spotty, both in terms of industry and geography. Some states are still struggling to deal with high unemployment and a lack of opportunities. In addition, long-term unemployment is a problem, with many job seekers giving up. Fallout from the recession also continues for state and local governments, which experienced notable declines in tax receipts when the economy went into recession.

Only about half of all states are back to their previous peak levels of tax collections, according to a study by the Pew Charitable Trusts. At one end of the spectrum is North Dakota, with collections now running more than 119 percent above their level before the recession, thanks to a major oil boom in that state. Illinois is up 23 percent and Minnesota is almost 21 percent higher. Texas compares well, with a rise of nine percent over the previous high level. However, many states continue to experience dramatically lower tax revenues: Alaska down 60 percent, Florida down 20 percent, many down more than 15 percent.

Of course, it’s crucial to note that tax revenue recovery can also be driven by policy changes. Many of the states now collecting more dollars have increased tax rates. In addition, state and local governments rely on a range of taxes. Income, property, and sales levies are the largest categories, but there are numerous other taxes and fees. Some of these revenue streams have recovered more quickly than others (notably property taxes are lagging in many real estate markets that are still depressed).

M. Ray Perryman
M. Ray Perryman

The drop in state and local tax revenue was steep during the downturn, with federal grants through the American Recovery and Reinvestment Act (ARRA or the “stimulus”) in 2009 helping only a little. Moreover, the recovery has been slow compared to other time periods, both for the economy and for tax receipts. Over the past few years, needed investments have been put off where possible given budget constraints. These deferrals only make the long-term problem worse. It will take time to work through the backlog, and with budgets stretched at the federal level, there is little hope of an infusion of funds from that direction.

During a recession, the need for funds rises, compounding what is already a big problem. Unemployment insurance costs, Medicaid caseloads, and other social services programs generally trend upward when the economy slows. Even with these higher costs, however, state and local governments typically have to balance their budgets. Cuts have been deep in some areas as a shrinking inflow of funds was spread ever thinner. In some cases, tax increases were viewed as the only answer, and most states enacted tax and/or fee hikes. Some refused to do so, relying instead on gimmickry, debt, and often severe cuts in services.

In the midst of all of this bad news, there are some potentially positive outcomes. To the extent that cuts led to greater efficiencies in providing services, there could be long-term benefits. Moreover, the trend toward transparency—whereby citizens can see exactly where tax receipts come from and where they are spent—escalated during the recession-induced struggles. In some cases, the lean years forced long-overdue restructuring of tax systems, enhancing their ability to meet future needs.  Mandatory balancing of budgets also means that many state and local governments are not facing mountains of debt to further delay the recovery process (although debt burdens did rise).

Texas’ tax structure is unique in that we are one of only a handful of states without an income tax on individuals or corporations (although the “margins tax” shares some similar characteristics). (Among the other states, only Nevada, Washington, and Wyoming have no income taxes; Alaska, Florida, and South Dakota tax individuals, but not corporations.) The Lone Star State also has no State property tax levy (unlike the majority of states), leaving that source of revenue strictly for local taxing entities.

In Texas, total state government tax collections in 2007 and 2008 were $40.3 billion and $45.5 billion, respectively, according to data maintained by the U.S. Census Bureau. In 2009, revenue dipped below $41.8 billion and fell further (to $39.5 billion) in 2010. The trend reversed in 2011, with a total of $43.2 billion, and 2012 taxes to the State were $48.6 billion. Last year’s $51.7 billion was far beyond the prior peak. Of that total, about $39.3 billion came from sales and use taxes, another $7.8 billion stemmed from licenses, and the rest from other taxes. The shale boom has been a major contributor.

It’s a good thing that revenue in Texas is rising, because there is notable work to be done. Highway funding is not allowing enough expansion to keep up with the growing population, and many roads are in need of work. Water shortages are reaching crisis points in some areas, and investments in additional capacity are needed. Education is always a priority, and our population expansion is adding students to the system.

The recent recession and the lingering aftereffects for state and local governments highlight the need for shifts toward more sustainable, efficient, and equitable sources of tax revenues. Although Texas is better positioned than many areas, the state has experienced budget challenges. Looking to the future, it is important to ensure that the economic and population growth also generates enough tax dollars to keep up with the expanding need for state and local services. This objective can only happen with some fundamental reforms.

<I>Dr. M. Ray Perryman is President and Chief Executive Officer of The Perryman Group (www.perrymangroup.com). He also serves as Institute Distinguished Professor of Economic Theory and Method at the International Institute for Advanced Studies.</I>