State revenues have suffered the steepest
decline on record during this recession. This likely will mean an even longer
recovery period for state and local budgets, which typically lag a couple of years
behind the end of a national recession. At stake are important services that
provide a foundation for shared prosperity as states slash funding that aids
disadvantaged children and adults.
While many states opted for a balanced
approach that included revenues instead of relying entirely on cuts, in some
cases states increased taxes and fees that disproportionately affect those with
low incomes. A number of states continue to levy income taxes on people below
the poverty line.
Federal and State
Action Needed in the Immediate-Term
Additional
Federal Aid Now Will Help Keep Programs Intact
Since the recession began, at least 45
states plus the District of Columbia have cut services critical to low-income
families, including health care and assistance to the elderly and disabled, as
well as investments in the future of our children like K-12 schools and higher
education. Currently, states face a collective budget gap of $180 billion for
the coming fiscal year and $120 billion for fiscal year 2012, and governors’ 2011
budget proposals were typically 5 to 10 percent smaller than what states spent
in 2009.
Were it not for the American Recovery and
Reinvestment Act (ARRA) passed by Congress in early 2009, the situation in the
states would have been much worse. Although states continue to teeter on the
fiscal precipice, the infusion of federal dollars helped fill as much as 30 to
40 percent of their budget shortfalls.
ARRA contained an enhanced federal match
for Medicaid that staved off cuts to health care for low-income families and
helped states respond to the growing need for public health care as people
continued to lose their jobs and insurance coverage. Likewise, establishment of
a State Fiscal Stabilization Fund helped avoid cuts to education, which accounts
for the largest portion of state spending. Both sources of aid sustained and
created jobs, helping to prevent the economy from faltering even more.
The Recovery Act not only provided aid to
states, but also put dollars directly in people’s pockets through expanded unemployment
insurance payments and food stamps, the Earned Income Tax Credit (EITC), the
Child Tax Credit, and a new, temporary tax credit for workers called Making
Work Pay. At the Center on Budget and Policy Priorities, we found these
provisions of ARRA lifted at least 6.2 million people out of poverty in 2009.
Finally, ARRA also helped to ameliorate some
of the recession’s impacts but, unfortunately, the money will be depleted
before state revenues recover to pre-recession levels. For this reason, more is
needed. Without further federal aid, if states cut spending this year at the
same level as last, it could cost the economy 900,000 jobs. Measures to extend the
Federal Medical Assistance Percentages (FMAP) through the end of 2011 have passed
both houses of Congress and extended education funding has been proposed. These
would be good starts.
A Balanced Approach Makes Sense
It’s not uncommon to hear lawmakers proclaim
that “families are tightening their belts during this recession, and the state
is going to do the same.” But they miss the other side of this coin: when families
have trouble making ends meet, they also look for ways to boost their income.
States should do the same.
In many cases, however, states have
relied too heavily on service cuts that especially affect the poor, children,
the elderly, and the disabled to fill budget holes. That presents a cruel
irony: when families battered by the recession need more help, the state
provides them less.
This not only hurts families—it’s also
harmful to the economy. Indeed, budget cuts slowed GDP growth by half
a percentage point in the first quarter of 2010. State spending on salaries, contracts,
and purchases is a stimulus that’s especially crucial when the private sector
is in a slowdown. Cuts in state spending have a ripple effect throughout the
economy, causing job loss because of a drop in overall demand. It’s a vicious cycle—the job losses only
increase the burden on state services.
A better alternative is a balanced
approach that includes revenue instead of relying too heavily on cuts. Some states have prudently increased income taxes
on the wealthiest households as a way to raise significant amounts from those
who can best afford it. A Center analysis found that if every state with an
income tax increased its top rate by one percentage point, and only on those
making $500,000 a year or more, it would raise about $8 billion nationwide.
Likewise, states can close tax loopholes and end credits for individuals and
businesses that cost states money and provide little to no economic benefit.
Among the 33 states that opted to raise
taxes or fees (or some combination of both) in 2008 and 2009, thirteen obtained
new revenue from personal income taxes. Other increases were more popular: 17 states
enacted sales tax increases, 22 increased excise taxes on tobacco, alcohol, or
motor fuel, and 24 increased fees or other taxes. Some 17 states increased
business taxes.
History shows that raising taxes in a
recession is a reasonable approach. Following previous recessions, states that
did so saw their economic performance improve just as much as states that
didn’t—and sometimes more. They recognized that in a severe economic crisis, no
one approach is enough—and relying too heavily on cuts jeopardizes recovery and
future prosperity.
Helping
People Up the Ladder
Federal and State EITCs: Policies that
Work Need Strengthening
State Earned Income Tax Credits play an
important role in reducing the impact that state and local taxes have on
low-income working families, just as the federal EITC does with payroll and
income taxes. Twenty-three states and the District of Columbia offer a state
credit, in most cases ranging anywhere from 3.5 to 40 percent of the federal
credit. Like the federal credit, most state EITCs are fully refundable, meaning
that filers whose income is too low to owe taxes receive a check to help
supplement their income. At the federal level, the credit lifts 6.5 million
people, including 3.3 million children, above the poverty line.
Because most state credits are a fixed percentage
of the federal credit, expansions to the federal Earned Income Tax Credit under
ARRA also improved state EITCs. ARRA provisions carved out a “third tier” that provides
families of three or more children with a larger maximum benefit. ARRA also
expanded the income eligibility limit for the maximum credit to a greater
number of married-couple, working families with low incomes.
While major improvements in the short
term, these key provisions are scheduled to expire at the end of 2010 if
Congress does not take action. Making
these provisions permanent, as proposed by President Obama in his fiscal year
2011 budget, will lower federal and state taxes for families with low incomes.
Even if these provisions are made
permanent, however, EITCs for workers without children remain too small to
fully offset federal income taxes for workers at the poverty line. Under
current federal law, a childless adult working full-time at the minimum wage is
ineligible to receive any EITC benefits, but would receive the maximum credit
if he or she had children. As a result, single, childless adults are the only
Americans that pay federal income tax on incomes below the poverty line; and
these workers also face substantial income, sales, and other taxes at the state
and local levels.
The Making Work Pay credit provided under
ARRA addresses this issue at the federal level with a $400 tax credit per
worker, but does not ease the state tax liabilities of single, childless
workers with low incomes. Improving the
benefit for childless workers under the federal EITC would automatically
improve state credits and help to reduce poverty.
Still, 27 states do not have an EITC and,
unfortunately, the substantial progress in the number of state EITCs created
over the past decade has been met with an increasing reluctance on the part of states
to finance new or expanded EITCs. Worse
yet, some states – for the first time – have reduced or proposed reducing state
EITC benefits in a shortsighted way to deal with the revenue shortfall crisis.
Many States Are Taxing the Poor
In addition to cutting critical services,
many states exacerbate poverty by taxing the incomes of the poor. A Center
analysis found that of the 41 states levying an income tax, eleven tax
single-parent families of three living at or below the poverty line (about
$17,000 in 2009). Thirteen states tax two-parent families of four living at or
below the poverty line (about $22,000).
For the near-poor and single filers
without dependents in their home, the picture is worse. Twenty-two states tax
single-parent families of three at 125 percent of poverty (about $21,400) and
25 states tax two-parent families of four at this income level ($27,400). Thirty-six states levy a tax on single filers
without children who live in poverty (about $11,000).
Despite long-term progress towards
reducing the tax liabilities of low-income families, only a few states made real improvements in 2009. As in
the case of state financing of new EITCs and expansions, revenue shortfalls of
the recession are an obstacle. That being said, lowering state taxes for
workers that earn poverty wages is good policy that improves workers’ ability
to meet basic needs at a relatively low cost.
Nicholas Johnson
is Director of the State Fiscal Project at the Center on Budget and Policy
Priorities.
Erica Williams is
a Research Analyst for the State Fiscal Project at the Center on Budget and
Policy Priorities.