Imagine you found a crisp $100 bill on the sidewalk. Let’s say you use the windfall to treat yourself to a nice steak dinner.
Alas, that’s what plenty of U.S. states have been doing.
In the wake of recent budget surpluses driven by a strong economic recovery and federal aid, states have gone on a tax-cutting spree. In 2022, at least 35 states and D.C. passed tax cuts, according to a forthcoming report from Tax Policy Center researchers Richard C. Auxier and David Weiner; include cuts passed in 2021, and the tally rises to 43 states. Some of those measures were temporary, but many involved large and permanent tax cuts, Auxier says.
And the bipartisan tax-slashing bender looks likely to continue this year.
For example, Georgia Gov. Brian Kemp (R) announced plans this month to give out $1 billion in income tax rebates, plus another $1 billion in property tax rebates, as part of what he calls “inflation relief.” New Jersey Gov. Phil Murphy (D) promised “significant tax cuts” on top of the $2 billion in property tax rebates handed out last year. Political leaders in Texas, Montana, Louisiana, North Dakota, Utah and Arkansas, among other states, want in on the action, too.
Not to be outdone, Mississippi Gov. Tate Reeves (R) is seeking the “complete elimination” of income taxes for his state, whose schools and basic infrastructure are already woefully underfunded. Tate apparently thinks that the Magnolia State’s roughly $500 million annual permanent tax cut, passed last year, was insufficient.
These fiscal plans are unbelievably shortsighted.
First, the idea that broad tax cuts provide “inflation relief” gets the problem exactly backward. A key reason the country has endured sharp price growth the past couple of years is that consumers have too many dollars chasing too few goods. Giving people even more cash to spend, without simultaneously expanding the amount of stuff the country produces, will not make inflation better.
Additionally, there’s no guarantee the strong revenue growth of recent years will continue. States enjoyed this windfall partly because consumers had been spending with a vengeance, after having been cooped up for months with comfortable savings (thanks partly to government transfer payments). More recently, their spending has begun to slow.
Congress also allocated upward of $1 trillion in aid to state and local governments through multiple covid relief bills, according to the Committee for a Responsible Federal Budget. This, too, gave states plenty of cash to play with — but only temporarily.
Despite guardrails Congress attempted to place on this aid to prevent it from “directly or indirectly” financing tax cuts, some got funneled toward tax cuts anyway. (Incidentally, this means that a lot of state-level Republicans enjoyed credit for popular tax cuts — while federally elected Democrats got blamed for the cost of those same cuts. Oops.)
There are far better uses for these federal funds than just handing them over to constituents through tax cuts. States and localities could spend their surpluses on rehiring workers who provide critical government services, such as teaching or sanitation. Public-sector employment is still well below pre-pandemic levels and basic government functions around the country have suffered.
Or, states could sock the money away for a rainy day — which might be on the horizon.
A recession is by no means inevitable, but the chances of one this year remain high, surveys of economists suggest. Recessions usually affect state budgets in two key ways: Tax revenue typically falls (because workers get laid off, businesses retrench and consumers cut back on spending); and demand for government safety-net services typically climbs (as more people become newly eligible for Medicaid and other programs).
This combination can crush state finances and, ultimately, drag on the private-sector recovery, as we saw in the aftermath of the Great Recession.
True, we didn’t see similarly devastating state budget crunches after the 2020 pandemic recession. That’s partly because of the unusual nature of that recession (i.e., who got laid off), and the generous federal aid that Congress began disbursing to states almost immediately (for example, through programs that enabled laid-off workers to continue spending).
But next time around, states should not assume Congress will come to the rescue as swiftly — if at all.
Republicans control the House and have advertised their appetite for austerity measures. If there’s a recession, GOP lawmakers might withhold stimulus to harm President Biden politically. Criticisms of Biden-era covid relief as too lavish — as evidenced by, ahem, how states are now squandering their surpluses — might also make federal lawmakers more tightfisted.
Yet states remain complacent. Worse than complacent: They’re actively sabotaging their own ability to respond to a crisis.