Opinion and Economic Analysis

Hicks: Falling state income tax revenue is bad omen

July 19, 2014

The last couple of weeks closed fiscal years for most state and municipal governments. This is a time to assess tax revenue and, for states like Indiana that operate on a two-year budget, to consider adjustments.

State income taxes are a good place to try to begin understanding state economic performance, because personal income is sensitive to changes in the economy. Moreover, the process of withholding our estimated tax liability from our paychecks makes income tax revenue a good early predictor of the state of the overall economy.

The past year tells an ominous story.

Nationally, from July through September 2013, growth in state income tax collections slowed appreciably. Only a few states were spared, and here in Indiana they actually shrank slightly, as they did in five other states.

Much of that shrinkage could be attributable to the budget deal of 2013, which eliminated a payroll tax cut of 2 percent and raised tax rates on high-income earners. This reduced taxable income and slowed the growth of economic activity enough to explain some, but certainly not all, of these declines.

This trend continued into the fourth quarter of 2013, with overall slowing pushing 11 states into full red due to revenue below the previous year’s. Six states, including Indiana, cut the budget at year end. All of this is an early warning signal of a slowing economy.

The first quarter of this year was a fiscal disaster, with only four states seeing growth in personal income taxes. Some of this could be attributed to a quarter in which the U.S economy shrank at a recessionary pace. The winter was harsh, and certainly affected the economy in many places.

The problem is that April revenues were much worse, and the expected rebound that should have accompanied the improvement in the weather failed to materialize. In fact, April’s losses were worse than the January-March income tax declines across the nation.

Some of the changes could be the result of lingering adjustment to the 2013 budget deal, and the impact of income tax reductions or more minor rule changes in a dozen states. But these changes and the weather cannot explain half the decline in tax revenue, and probably much less. Something else is going on in our economy.

Virtually no residential construction jobs were created in May and June, signaling a stalled housing market and perhaps a broader weakness in the economy. For most states, including Indiana, this means more belt-tightening awaits us in 2015.•

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Hicks is the George and Frances Ball distinguished professor of economics and director of the Center for Business and Economic Research at Ball State University. His column appears weekly. He can be reached at cber@bsu.edu.

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