State income tax revenues are up—but the bubble’s about to burst

September 24, 2013

(Daniel Acker/Bloomberg.)

The second quarter of this year was good to state governments. But a bubble appears ready to burst.

States hauled $260 billion in total revenue during the second quarter of 2013, up 9.4 percent from the same period last year, according to new Census data. The largest source of revenue was income taxes, which accounted for more than two-fifths of the total and was up 19 percent from the year before.

But a strong three-quarter run is about to come to an end, according to experts at the Nelson A. Rockefeller Institute of Government, a public policy research think tank at the State University of New York.

“It can’t last at the same pace, not for the income tax in particular,” says senior fellow Don Boyd, who, along with a colleague, wrote about the issue last week. “The reason that can’t persist is that it clearly reflected a lot of acceleration.”

That “acceleration” was largely driven by the end-of-2012 fiscal cliff fight (remember that?) over tax hikes and spending cuts. The fear of higher tax rates on investment income this year, led a lot of taxpayers to shift more of their tax burden in 2012. That shift played out from the final quarter of 2012 through the first half of this year, as taxpayers prepared for and filed their 2012 returns. (A California tax hike also elevated the totals.)

State income tax revenues have shown year-on-year growth for 14 straight quarters, but that could come to an end soon.

“At a minimum there will be a dramatic slowdown by the fourth quarter of this year and maybe even some declines in personal income taxes,” Boyd says.

Fortunately for states, it’s not exactly like local experts haven’t seen this coming. States that take forecasting seriously or rely heavily on income taxes, such as California and New York, have seen this coming for a while. But the problem is making sure that lawmakers understand the recent revenue growth is not due to widespread economic improvement, but rather a one-off quirk of federal policy.

“They have to resist the temptation to treat it as recurring money,” Boyd says.

Income taxes accounted for 69 percent of second-quarter revenue in Oregon, more than any other state. In New york and Massachusetts, income taxes constituted a three-fifths share of total revenue, while its share in Colorado and California was 57 percent and 56 percent, respectively.

Niraj Chokshi reports for GovBeat, The Post's state and local policy blog.
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