Budgeting Tactics for States

Tax Foundation state projects director Joe Henchman writes in today’s Daily Caller about five ideas to help states facing budget shortfalls (that is to say, virtually every state) get back in black:

  • Prioritize appropriations. When the majority-Democratic Arkansas Legislature votes to appropriate money, the money isn’t immediately spent. Instead, each appropriation goes to a legislative committee that ranks them in order of priority. Items are funded only to the extent money is available, forcing debate about how best to allocate limited resources while permitting a wish list if revenue exceeds expectations.
  • Review tax incentive programs. Although many states recognize they have burdensome tax systems, they use targeted incentives for particular industries rather than reducing burdens for everyone. Besides dumping a higher tax burden on everyone else, the jobs created are dependent on the handouts and often vanish when the incentives end. Tax incentive programs also often escape oversight and cost-benefit analysis. Iowa recently recommended elimination of several ineffective tax incentives after a review. Other states should do the same.
  • Broaden sales taxes and use the revenue to lower tax rates. A good sales tax applies to all final goods once and only once. Exempting clothing and groceries may seem like a good idea, but doing so causes year-to-year revenue instability and drives up the rate on everything else. Gross receipts taxes and taxes on business inputs cause distortions that harm economic growth. Adopting a sales tax base of all final products and services would enable both lower rates and more predictable revenue.
  • Reduce reliance on taxes on high-income earners and corporate profits. When deciding in which state to live or locate their business, one of the factors that top earners must weigh is the marginal tax rate they will face in each state. While high statutory tax rates on high incomes may bring a revenue increase in the short term, they can harm long-term economic growth as providers of jobs and capital choose to locate in lower-tax states. With these volatile revenue sources at a minimum, it may be perfect timing to minimize them.
  • Establish rainy day funds and spending restraints. To ride out recessions, states need to build a rainy day fund of 12 to 18 percent of their annual spending. Setting aside 2 to 3 percent of each year’s budget in good times can accomplish that, but those structures need to be in place now or else states will be in this mess again.

Joe discussed state tax policies on C-SPAN earlier this month.

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