The Most Important Public Finance Issues to Watch in 2023
Last year, state legislators were able to have their cake and eat it, aggressively lowering taxes while significantly expanding expenditure, while also amassing record reserves in their rainy-day coffers. The good times are still here — most states have surpluses — but there are grounds to be concerned. Inflation has eased slightly, but it is still eating away at real revenue growth. And the potential of a struggling economy – what economist Mark Zandi refers to as a “slowcession,” if not a full-fledged recession – has some legislators concerned.
Nonetheless, there is a strong appetite for both fresh expenditure and sustained tax cuts. “2022 will undoubtedly go down in history as one of the most successful tax-cutting years,” says Jonathan Williams, chief economist at the conservative American Legislative Exchange Council. He expects to see more given the large stockpiles. As the new year begins, big cuts are being promised not only in the capitols of conservative states like Iowa and Texas, but also by Democratic governors in states like Connecticut, Kansas, and Wisconsin.
Even as the urge to reduce taxes persists, spending is increasing. State legislators are benefiting not only from their own healthy income, but also from significant additional funding from Washington in sectors like as infrastructure, clean energy, and public health. While businesses continue to spend money on big-ticket products like broadband, they must simultaneously raise wages to compete in tight labour markets. Here’s our projection for public finance to help you better understand the impact of budgets, inflation, and taxes on this year’s legislative agenda.
It’s one of those situations where you have the best of times and the worst of times. State budgets are currently in fantastic health. Many states have surpluses, and their rainy-day coffers are at all-time highs.
In contrast to the easy partying that more federal money provided for them last year, lawmakers are concerned about inflation and the better-than-average probability that the economy could enter a recession this year.
Over the last few years, states have tripled the amount of money in their rainy-day accounts, leaving them with a total of $343 billion in reserve. “In Arkansas, we’ve been fortunate in that we’ve been able to decrease taxes while also having $1.2 billion in our catastrophic reserve fund and a $1.6 billion surplus on top of that,” says Matthew Shepherd, speaker of the Arkansas House. “However, we recognise that the picture may change in the future.”
Many other states are already reaping the benefits. Wisconsin has a $6.6 billion surplus, an all-time high. Georgia occurs to have a surplus equal to that amount. Texas has a $27 billion surplus, which will almost certainly result in a significant property tax cut.
In 2022, ten predominantly red states will reduce individual income tax rates. More will be added this year. In December, North Dakota Gov. Doug Burgum proposed a budget that would give his state the lowest flat-rate income tax in the country, at 1.5 percent.
Some economists warn that states should not use temporary surpluses to reduce interest rates permanently. They favour the method used by a number of blue states last year, which included sales or gas tax holidays, as well as one-time refunds and rebates. “I always think there’s a risk that when things are going well, states would slash taxes, which may cause issues later,” says Ron Fisher, an economist at Michigan State University.
The same may be said regarding spending. States have done a lot of this. According to the National Association of State Budget Officers, general fund spending will grow by 18% in fiscal 2022. It is expected to rise another 7% in the current fiscal year.
Most states’ rainy-day funds have prepared them rather adequately for any downturn, but they must still be concerned about rising prices. Low unemployment and staffing shortages are exerting increasing pressure on state employee compensation, while inflation and supply chain issues have increased the cost of infrastructure projects. California, for example, is already facing a $24 billion shortfall in the coming fiscal year, which begins on July 1. Even though employment in the state has expanded significantly, tax receipts are significantly lower.
Fitch Ratings examined the fiscal circumstances of the 15 largest states between July and September and discovered that California was the only one with lower tax receipts than the previous year. However, by the fall, the national revenue picture had already begun to deteriorate. Although total state tax receipts increased, they decreased in actual terms due to inflation. “It seemed to me that in times of uncertainty, governments should be stable and not make many changes,” Fisher adds.
Inflation in 2023
Even though economic indices are returning to pre-pandemic levels, the consumer price index surge last year, the largest in 40 years, threatens to derail the recovery. There are numerous theories as to what caused the recent increase in inflation. States and localities are left to deal with the repercussions of a torrent of federal money connected to COVID-19 relief, a rapid increase in consumer demand, supply chain concerns, or, more likely, a mix of things. But not without assistance.
President Biden’s $1.9 trillion American Rescue Plan contains $350 billion in emergency aid for state, local, and tribal governments to be used in COVID-19 recovery efforts, maintenance of key government services, and long-term economic growth. Rather than additional spending, much of the money was utilised to make up for lost tax revenue owing to the pandemic. Recipients must use the funds by the end of 2026.
States have profited from increased sales and income tax revenue as a result of inflated prices paid for goods and services and higher wages, in addition to stimulus funds. Several states have enjoyed double-digit gains in tax collections in recent years, resulting in budget surpluses. States’ investments have grown enormously in value as interest rates have risen. However, fluctuating property taxes due to an unstable housing market, along with reduced government help and increased costs of providing services and capital projects, will make maintaining the status quo challenging.
Since 2020, the cost of building materials has risen at a much faster and higher rate than the consumer price index. Unexpectedly high pricing, supply concerns, and a labour scarcity have led states to reconsider projects and how to fund them. Virginia set aside an additional $200 million last year for anticipated inflation-related cost overruns on roadway projects in order to protect the contractors on whom it relies.
Following many rounds of federal assistance and higher-than-expected tax revenues, many states are drawing on rainy-day funds and budget surpluses to provide inflation relief to their residents. Almost half of the states have already issued or plan to offer one-time rebates and enhanced tax credits this year. The majority of the relief funds come from budget surpluses and are given through legislative edicts or automatic rebates. Some analysts are concerned that the payouts will do little to alleviate the agony of inflation and may instead worsen the situation.
California will have delivered more than 23 million qualifying taxpayers inflation relief payments ranging from $200 to over $1,000 by the end of January. Colorado had planned to return $400 to each taxpayer in 2023, but due to the state’s robust economy, the sum was upped to $750 and bumped ahead a year. Families in New Mexico got a total of $1,500 in rebates and tax credits last summer.
State rainy-day funds and budget surpluses are likely to remain at record levels after two years of expansion. Lawmakers will face an uncertain economy and dramatically less federal help. Continued high inflation reduces government spending power and jeopardises the COVID-19 recovery.
Following the roller coaster ride of the early COVID-19 days, states have seen tax collections stabilise and even grow faster than before the epidemic began. States’ reasonably robust financial situation has resulted in a trend of tax cuts and rebates. However, the year 2023 holds many unknowns for the economy and, as a result, state tax policies.
States have adopted “an unprecedented quantity of tax-rate decreases” in the last two years, according to Jared Walczak, vice president of state programmes at the Tax Foundation, a right-leaning think tank. According to Walczak, 27 states have eliminated a significant tax, while 21 have reduced income tax rates. Another minor trend has been the transition of a few states from graduated-rate income taxes to flat taxes. Because of the possibility of a recession, the rate of tax reduction is likely to stall in 2023. But, according to Walczak, states now have a bigger tax base than they did before the Tax Cuts and Jobs Act of 2017, and the baseline they’ll return to after a slump is higher than before.
While revenue collections have been high, states have found it difficult to implement “innovative new taxes” such as digital services taxes, stock transfer taxes, and other taxes on the wealthy, according to Walczak. However, if the economy continues to deteriorate, some of these ideas may regain traction. Many economists forecast weaker growth, if not an outright recession, in 2023, as well as a “gloomier prognosis” for state revenues than in recent years.
The trend of state tax cuts and rebates has had significant outliers. In Massachusetts, voters approved the so-called Fair Share Amendment, which levies taxes on those with annual incomes of more than $1 million. The proceeds of such tax are meant to fund transportation and public education improvements. According to Walczak, the close vote — the tax was approved by 52 percent of voters, while Democrat Maura Healey was elected governor by 64 percent — demonstrates that voters are generally sceptical of wealth taxes and “need to be convinced” that they are worthwhile, even in progressive states like Massachusetts. In November, a plan in California to boost taxes on anyone earning more than $2 million was overwhelmingly defeated, even as Los Angeles voters approved a mansion tax tosupport homelessness efforts.
According to Aidan Davis, state policy director at the left-leaning Institute on Taxation and Economic Policy, states are generally trending in two directions on tax policy. Those tendencies, which closely correspond to party control, are expected to persist. However, the general inclination for tax cuts over the last two years could shift fast if the economy enters a slump. Despite robust collections and federal COVID-19 relief monies, Davis claims that many state-level cuts were undertaken without widespread political recognition of what was being sacrificed in the long run. According to polls, the majority of Americans favour increased taxes on the wealthy. In the case of a downturn and lower state revenues, another round of progressive tax rises is possible.