Revenue Rebound

States of Plenty January 11, 2006; Page A14

Just prior to his state of the state address last week, Governor George Pataki announced that New York is looking at a $2 billion surplus this year, or twice what was predicted just three months earlier. Two days later, Governor Arnold Schwarzenegger said California would end the fiscal year with a whopping $5.2 billion in reserves. Arkansas, Florida, Maryland, Oklahoma, Virginia and about three dozen other states are also reporting revenue above forecasts. What's going on here?

A lot of underreported economic good news, that's what. According to the National Conference of State Legislatures, states have closed an aggregate $264 billion budget gap since 2001. "State budget conditions continue to improve, showing signs of recovery in nearly every state," says the report. "Buoyed by robust revenue performance, states are collecting more revenue than they projected for nearly every major tax. In some cases, collections are significantly above forecasts."

There's some policy irony here. In order to vote for the Bush tax cuts, some liberal Republicans insisted on a $20 billion giveaway to the states to offset what they thought would be "lost" revenue. But the revenue data show that the Bush tax cuts and the economic expansion that has followed have been a windfall for state coffers.

Since the tax cuts passed in mid-2003, GDP growth has averaged close to 4%, the jobless rate is down to 4.9%, and federal tax receipts have climbed at the fastest pace in more than two decades. More workers and rising incomes translate into more taxable income for states. And because most states tax investment income too, state budgets are also benefiting from an increase in corporate dividend payouts. If the states were smart, they'd offer to repay the $20 billion if Washington will make the tax cuts permanent.

As usual, strong profits on Wall Street are playing a central role in New York's recovery. California cites higher-than-expected corporate tax revenues. In Connecticut, where a $524 million surplus is anticipated, officials point to capital gains on stock sales as the biggest factor. And in Virginia -- where Democratic Governor Mark Warner pled poverty two years ago in order to push through a record tax increase -- a hefty $1.1 billion surplus has been projected. Even some Republican governors, like Mitch Daniels of Indiana, found themselves pushing prematurely for tax increases. For the first three quarters of 2005, Indiana's state tax receipts are up 6.3%.

In fact, the state budget "crisis" that we've been reading about for the past few years always had more to do with overspending than revenue shortfalls. Using Census data, Chris Edwards of the Cato Institute calculates that state revenues did drop 3.2% in 2002, but they rebounded by 4.2% the next year. States saw revenue growth of 8.7% in 2004 and an estimated 8% last year. In other words, if budgets weren't being balanced, it's not because the taxpayers weren't doing their part.

State politicians will claim these newfound riches shouldn't be returned to taxpayers because of rising Medicaid costs. And it's certainly true that that program is claiming a higher and higher percentage of state budgets. But that's not an argument against tax cuts; it's an argument for Medicaid reform. And history shows that, given their druthers, state politicians would much rather use boom cycles to placate special interests by expanding entitlements rather than reforming them.

Voters might also keep all this in mind during the next economic downturn, when their state politicians come asking for more money to tackle problems that they lacked the discipline to address when their coffers were full.

	URL for this article: http://online.wsj.com/article/SB113695191556343524.html

Copyright 2006 Dow Jones & Company, Inc. All Rights Reserved