An occasional publication of economic research and commentary that centers on a regional or national issue, often with emphasis on the Eighth Federal Reserve District. Written for a generally informed readership.
OCTOBER 2010 Vol. 6, No. 1
State and Local Government Finance Amid Economic Turbulence
Proceedings of a conference co-hosted by the Federal Reserve Bank of St. Louis and the Weidenbaum Center at Washington University in St. Louis on the current status of state and local public finance, fiscal federalism in the United States, an economic evaluation of state and local taxes, and non-traditional revenue sources for state and local governments, April 9, 2010.
The State of State and Local Government Finance
This paper provides an overview of the state-local government sector, a review of the short-run impact of the 2007-09 recession on state and local governments, and a brief summary of key long-run challenges state and local governments will encounter in the next decade. State and local governments in aggregate represent about one-seventh of the U.S. economy, with education
and welfare (mostly Medicaid) accounting for more than half. These governments currently face nearly unprecedented fiscal turmoil as a result of the recent recession.
State Tax Revenue Growth and Volatility
Macroeconomic conditions and tax structures jointly determine the growth and volatility of state tax revenues. Since a variety of economic conditions exist among states, government policymakers
should carefully anticipate and consider the possible impacts of proposed tax reform and revenue enhancements on the long-term growth and volatility of their unique tax revenue portfolios. In the
short run, states generally cannot alter the volatility and growth rates of their economies.
States in Fiscal Distress
The 2007-10 recession has imposed significant fiscal hardships on state and local governments. The result has been state budget deficits and the need to increase state taxes, cut spending, and withdraw funds from state “rainy day” accounts. The primary cause of state budget “gaps” has been the rise in the level of state unemployment.
Can State and Local Governments Rely on Alternative Tax Sources?
State governments are much more likely than their local counterparts to depend on taxes other than sales, property, and personal income taxes. Excises on alcohol, beer, tobacco, gambling, and
business taxes are among the alternative taxes. Local governments, on the other hand, are more likely to impose user fees. Reliance on these alternative state tax sources in aggregate has diminished over the past several decades, despite a pattern of rate increases and new gambling alternatives.