More Municipal Finance Wonkery

By Fester:

The New York Times is catching up to the bloggers as they report the states and local governments are getting hammered and the recessionary budget cycles have barely begun. 

State tax revenues, adjusted for inflation and tax cuts, fell 5.3 percent in the first quarter of 2008 compared with the same time a year ago, according to a report to be released Tuesday; it was the third quarter in a row that total adjusted revenue declined. The first quarter revenues were the weakest among states since early 2003.

Sales tax revenues, the beating heart of many budgets, were essentially flat for the first time in six years. Corporate income taxes declined 5.1 percent from January to March compared with the same period the previous year — the third straight quarterly decline. And 12 states showed a falling off in personal income taxes, though revenue from those taxes rose 4.4 percent nationwide....

Unlike other economic downturns, when states were hurt by faltering corporate and personal income tax revenue, problems this time appear to be led by declines in sales taxes, prompted in large part by the issues with the housing market. This has been particularly painful for states like Florida and Tennessee that have no personal income tax and rely on people buying things. 

This is a harbinger as most indicators of contraction did not start lighting off until December 2007 or January 2008.  The short term response by individuals to tough times is to hunker down and use up individual reserves to smooth consumption patterns from the good times.  Those reserves were thin going into the stagnation and can not be counted on to bridge the peak to trough declines that we can anticipate. 

The next response is to cut back on truly discretionary items, and it is in this area that states will be hammered. Most states do not apply their full sales tax to groceries, medical care, some services, and fuel.  Those items are seen as necessary and fundamentally non-discretionary in family budgets.  So sales taxes often fall upon items that have higher elasticity of demand and people can do with less or without.  It is this category of goods that states tax that is seeing the fall-off as individuals react to incomes that either are falling or they fear will fall, and as dollars are shifted towards non-discretionary purchases as energy, food and healthcare costs increase. 

The states will be hammered and there will be very little that they can do as 98% have a balance budget constraint and most have already borrowed most of their prudent borrowing capacity.