December 14, 2012

How the Federal Fiscal Cliff Will Shift to the States

'Not only do states face their own cliffs, but ... they also will be greatly affected by what happens in Washington,' says Tax Analysts' Bergin

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The fiscal cliff negotiations currently taking place in Washington will have both good and bad effects on states’ revenues, a panel of tax experts said Friday.

While state budgets are still reeling from the great recession of 2008, which caused states to face their “biggest challenges in 70 years,” they face further budget upheaval as the federal government addresses the fiscal cliff and sequestration cuts, said Nicholas Johnson, vice president for State Fiscal Policy at the Center on Budget and Policy Priorities.

Johnson joined a panel of tax experts during a conference at the National Press Club sponsored by Tax Analysts, which provides non-partisan tax news and analyses. The panel of tax experts examined issues related to “state fiscal cliffs” and their implication for state tax policy.

“Not only do states face their own cliffs, both short and long term, they also will be greatly affected by what happens in the coming weeks in Washington,” said Tax Analysts President and Publisher Christopher Bergin. "There’s a real connection between the federal budget and state budgets that many people in Washington don’t spend much time thinking about, one that could ultimately wind up with states feeling some of the greatest effects of the fiscal cliff.”

Bergin moderated the discussion, which in addition to Johnson included Donald J. Boyd, co-executive director of the Task Force on the State Budget Crisis; Joseph Henchman, vice president for Legal & State Projects, Tax Foundation; and Cara Griffith, legal dditor of State Tax Notes.

Johnson noted that states are still feeling the effects of the recession, including “reduced funding for K-12 education, the drain of rainy day reserve funds, and the underfunding of pensions, with little prospect of improvement in the coming months.”

He noted that there are potential “huge threats" from the deficit reduction process where costs will be shifted to states. While Medicaid is off the table, he said, “non-defense discretionary funding--the funding of vital services such as education, infrastructure, and more is threatened at a time when states can ill afford it.”

Griffith added that the tax changes that are scheduled to occur on Jan. 1 “include both good and bad news for state tax revenue.” The good news, she said, is that “lower federal deductions could mean more income being taxed at the state level, resulting in higher state tax revenues for some states.” However, the bad news is that “reductions in federal spending will significantly affect funding for the states, many of whom rely on up to one-third of their budget from federal grants. State credit ratings are also at risk.”

Griffith went on to say that “the combination of the federal fiscal cliff and state’s long-term fiscal challenges means that states must plan for the future.” Given the tight budgets since the recession, “the potential for a decrease in federal funding as a result of the fiscal cliff, a possible elimination of the deduction for state and local taxes, and the fact that most states must balance their budget each year, states do not have the ability to put off planning for the future.”

Boyd with the Task Force on the State Budget Crisis highlighted six primary issues affecting states that were identified by the Ravitch Volcker Task Force on the State Budget Crisis: “Medicaid spending growth, a focus on federal deficit reduction, underfunded pensions, volatile taxes and a narrow and eroding tax base, local government fiscal stress, and state budget laws and practices are some of the major issues that states face today,” he noted. “We recommend that states undertake greater transparency, better disclosure of liability, better forecasting, and increased risk disclosure and funding of pensions. For the federal government, we believe that there needs to be a federal process that considers the impact of policy decisions on states.”

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