The Nelson A. Rockefeller Institute of Government recently released its quarterly state revenue report, showing steady but sluggish growth in state tax collections.

“State tax revenues have grown now for 12 consecutive quarters. However, such growth has been slow and states continue facing the fiscal challenges created by the Great Recession,” according to Lucy Dadayan, a senior policy analyst at the Rockefeller Institute and one of the report’s co-authors.

In the interview that follows, Ms. Dadayan explains how this latest report, entitled, “States Are Not Out of the Woods Despite Strong Revenue Gains in the Fourth Quarter, fits into the recent state revenue trends – and the public’s perception of states’ fiscal conditions.

MuniNet: Slow but steady growth in state tax revenues sounds like states are working their way back to fiscal health; but we’re not there yet, are we? Is it too soon to say that states have recovered?

Dadayan: Despite increases over twelve quarters – a full three years of continual gains – overall tax collections are still comparatively weak by recent historical standards. States might be seeing more revenue than expected, and more revenue compared to the previous years, but that is not an indication that states are out of the woods. Growth in tax revenues has been steady, but sluggish except for the fourth quarter of 2012.

“States might be seeing more revenue than expected, and more revenue compared to the previous years, but that is not an indication that states are out of the woods.”

Our research, as well as research done by others, including the most recent report by the General Accounting Office (GAO), indicates that state and local governments continue to face long-term fiscal pressures, along with growing revenue and spending imbalances.

MuniNet: What could the spike in revenues in the last quarter of 2012 mean for state finances?

Dadayan: States reported rather strong growth in overall tax collections at 5.2 percent in the fourth quarter of 2012, which is stronger in comparison with the previous five quarters. However the strong growth in overall tax collections is at least partially attributable to the artificially propped up personal income tax collections. The strong growth in personal income tax collections is due to the acceleration of income into calendar year 2012 by some taxpayers in an effort of avoiding paying higher rates on several types of income, including capital gains, caused by the “fiscal cliff.” This strong growth in personal income tax collections, particularly in estimated tax payments, in the final quarter of 2012 is simply borrowed from the future and will make it harder for state officials to reliably forecast income revenue in the coming quarters and will create new challenges for the states.

“High reliance on a single type of tax may lead to more revenue volatility, particularly during the economic downturns and depending on the nature of the downturn.”

MuniNet: Many states are contemplating changes to their tax structures. Could this help to promote growth in state revenues?

Dadayan: State tax revenues became very volatile in the last decade. One of the key determinants is the composition and structure of the tax portfolio in a given state. High reliance on a single type of tax may lead to more revenue volatility, particularly during the economic downturns and depending on the nature of the downturn. In addition, the taxpayers’ fear of the “fiscal cliff” and their subsequent behavior, the federal government’s provisions under the American Taxpayer Relief Act, and state officials’ temporary measures to address budget shortfalls caused by the Great Recession, all have directly or indirectly contributed to the growth of tax revenue volatility in the last few years. It is time for the state officials to take actions such as re-examining the composition of tax structures and broadening tax bases in order to address revenue volatility and accelerate the extremely slow recovery of tax revenues.

MuniNet: Some news accounts have referred to a surplus in many state budgets. How can the general public reconcile this seeming contradiction?

Dadayan: The difference is really more attributable to how news is packaged and delivered – and whether we see the glass as half-full or half-empty. In a recent National Public Radio interview, entitled “States Question What to Do with Surging Tax Revenue, Scott Pattison of the National Association of State Budget Officers, correctly notes that improvement on the revenue side should not be celebrated without looking into spending side and being on alert for the growing pension liabilities.

States should be prepared to address reductions in federal grants to state and local governments as a result of sequestration. If federal grants to state-local governments were cut by 10 percent, that would be more than $60 billion annually, which is more than tax increases enacted by states for 2008 through 2012, in response to fiscal crisis caused by the Great Recession. Cuts in federal grants would cause considerable fiscal stress.

In addition, state and local governments experienced the largest cuts in public sector employment. As of March 2013, the state and local governments lost about 718,000 employees since the peak employment levels reported in August of 2008. The large cuts in public sector employment led to large cuts in government services.

Presenting the glass half-full is not an uncommon strategy for politicians, particularly around the election time. The truth is that while state tax revenue is recovering, it remains well below where previous trends would have suggested in the absence of the Great Recession. Therefore, states should not rush into celebrating surplus seen in state budgets.

About the Expert

Lucy Dadayan is a senior policy analyst at the Rockefeller Institute of Government. She has conducted research and co-authored reports on state and local government fiscal policy issues; state spending on public policy programs and the effects of state fiscal capacity and economic changes; fiscal issues and organizational challenges of the K-12 education system in New York State; and state and local government administration of the Workforce Investment Act.

Dadayan holds a Ph.D. in Informatics at the University at Albany.