Report: Wealthy states suffered more during recession

During the recent recession state tax revenues dropped proportionately more in high-income states than in low-income states, according to a recent Rockefeller Institute of Government report. This fact tells a lot about the nature of the recession. The Rockefeller Institute data also show that Washington state’s revenue held up well in comparison to other high-income states, and this points to one of the strengths of the state’s tax system: its stability.

Data obtained compares the average percentage changes in general fund tax revenues from fiscal year 2001 to 2003 for states grouped in quartiles according to average per capita personal income. Among states in the top income quartile, average tax revenues dropped by 6.66 percent from 2001 to 2003; in the second quartile, average revenues dropped by 4.05 percent; in the third quartile, they dropped by 1.23 percent. Among states in the lowest income quartile, average tax revenues actually increased slightly, 0.14 percent, from 2001 to 2003.

The effects of the recession were concentrated in the nation’s higher income states. The technology boom that fueled growth in the late 1990s was felt most strongly in these states; when the bubble burst, the worst effects were also concentrated there. This parallels the smaller-scale pattern within the state of Washington, where the recession has been most severe in the higher income counties in the central Puget Sound region.

While Washington was one of the states in the top income quartile, ranking 11th highest in average per capita personal income for the 1998-2000 period, its revenue performance was much better than the group average, as shown in ranking states from worst to best by the percentage change in general fund tax revenue from 2001 to 2003.

Washington ranks 32nd on this list, with 2003 tax revenues a scant 0.13 percent greater than 2001 tax revenues. For each of the 31 states above Washington on the list, 2003 revenues fell short of the 2001 level.
Washington was one of the centers of the tech bubble; weakness in aerospace employment, however, dampened the peak of the business cycle here. Thus, although the state has had one of the nation‚s weakest economies for the past two years, the fall from pre-recession heights was not extraordinarily great. This is one reason the state’s tax revenue performance looks relatively good.

One of the virtues of Washington’s lack of a state income tax is that the revenue stream is not as volatile as those of many other states that have such a tax. The Washington State Tax Structure Study Committee found that a flat rate income tax by itself would be significantly more volatile than the state‚s existing tax system. Furthermore, the committee found that reducing the state sales tax rate from 6.5 percent to 3.5 percent and replacing the revenue through a 2.6 percent personal income tax would result in a system that was somewhat more volatile than the existing tax system. Adding 2.3 percent flat income tax, dropping the sales tax rate to 3.5 percent and applying the sales tax to food would result in a tax that was roughly equal to the volatility of the existing system.

Some people believe the budget gap that the legislature faced last spring would have been less severe if the state’s tax system included an income tax. This is not true. With an income tax the problem would have been worse. (Look at Oregon and California.)

Rather, the culprits for our large budget gap were on the spending side, where large increases in expenditures for certain programs were slated under existing laws. Of particular note were medical cost inflation in the Medicaid program and the increases in K-12 spending mandated by Initiatives 728 and 732 that were suspended in the 2003 budget. To avoid further problems in the 2005-2007 biennium, lawmakers will need to show continued restraint in the supplemental budget under consideration in 2004.