Tax day is fun for two groups of people: accountants who end a hectic busy season, and state governments that rely on tax dollars to fund necessary operations. But this year, states across the country are noticing a disturbing drop in tax revenue for the first time since the end of the great recession — thanks, in large part, to a hangover from the 2012-2013 fiscal cliff.
Total personal income tax revenue fell by 0.4 percentage points in the first quarter of 2014, according to data compiled by the Rockefeller Institute, the first year-over-year decline since the last three months of 2009. Corporate tax revenues declined in 20 states, while personal income tax revenues fell in 10 states.
The declines don’t come as a total shock, budget analysts in those states say. Some come as a result of state tax cuts passed by legislatures last year. Others are blamed on bad weather that froze much of the country this winter. But the bulk of the decline comes from two particular events at the federal level: The fiscal cliff, narrowly averted in the first days of 2013, and the Affordable Care Act — both of which created a spike in tax revenues in early 2013.
A series of negotiated deals over the federal debt ceiling and extending tax cuts first passed under President George W. Bush set a daunting deadline for members of Congress just after the 2012 elections: The tax cuts, spending cuts known as budget sequestration and other key tax laws all faced a New Year’s Day deadline. Congress avoided going over the cliff, which would have meant higher taxes and steep spending cuts that economists warned would have sent the economy into a recession, in late-night votes on Jan. 1, 2013.
But the partisan gridlock built up before and after the 2012 elections gave money managers, corporations and high-income earners reason to be skeptical. Many businesses and individuals took income or sold stock in the last weeks of 2012 that would otherwise have been realized the following year, in order to avoid higher tax rates. A 3.8 percent surcharge on investment income on taxpayers who made more than $250,000 a year, imposed by the Affordable Care Act, also inspired wealthy investors to cash out before the beginning of 2013.
Taxes on that income, taken in late 2012, would hit state coffers in the first half of 2013, when taxpayers filed their returns. Indeed, states reaped huge windfalls in the first and second quarter of last year, when personal income tax revenue soared 18 percent over the prior year and corporate income taxes rose about 10 percent.
“We had this unusually strong year in 2013, attributable in a lot of places to capital gains income dynamics,” said Brenna Erford, who manages state budget policy work at the Pew Charitable Trusts. “A lot of taxpayers were making this very conscious choice to take those gains in the prior year to avoid tax changes.”
The windfall states experienced in 2013 meant that revenue wouldn’t roll in to state coffers the following year, in 2014. On their face, the numbers are startling: In the first three months of the year, personal income tax revenue dropped 15.3 percent in Maine, 4.1 percent in Iowa, and 3.7 percent in both Mississippi and South Carolina.
But because of unexpectedly strong growth in 2013, the declines in 2014 represented more of a return to the norm than any factors worthy of concern. “States did recognize the potential decline in revenue in the first quarter of 2014 and budgeted accordingly,” said Emily Raimes, a vice president at Moody’s Public Finance Group who deals in state government credit ratings.
“The fiscal cliff deal skews what the prior year number means in a lot of states,” said Christian Soura, South Carolina Gov. Nikki Haley’s deputy chief of staff for budget and policy. “Many corporate interests had tax reasons to recognize profits at the end of calendar year 2012 before the fiscal cliff took effect.”
California had a particularly precipitous drop, thanks to another factor: Wealthy investors who sold stock in 2012 had to pay extra in taxes after a voter-approved initiative boosted capital gains taxes retroactively. That meant California collected even more capital gains taxes in early 2013, when those 2012 taxes came due, than it would have otherwise. Personal income tax revenue returned to earth, dropping 11.1 percent in the first quarter of 2014.
“The growth that we’ve seen in revenues is tied to capital gains, which is the most volatile source of revenue there is,” said H.D. Palmer, a spokesman for California’s Department of Finance. “We weren’t caught by surprise by it. We knew there were some factors that would cause the prior year to be higher than it normally would have been.”
Some states that didn’t take adequate steps to plan ahead are suffering. Standard & Poor’s and Fitch Ratings both downgraded New Jersey’s credit rating after the state disclosed an $807 million budget gap last week, forcing painful cuts just two months before the end of the fiscal year. Moody’s cut Kansas’s bond ratings after tax revenues dropped 45 percent from a year ago, in part due to the fiscal cliff. Gov. Sam Brownback, R, blamed the Obama administration.
“What we are seeing today is the effect of tax increases implemented by the Obama administration that resulted in lower income tax payments and a depressed environment,” Brownback said in a statement.
Still other states saw tax revenues fall after implementing new tax cuts. Ohio Gov. John Kasich, R, signed personal and small-business tax cuts into law last year; this year, personal income tax revenue collected in the first quarter fell 19.3 percent and corporate income tax fell 91.6 percent over 2013 levels. North Dakota, which also cut income taxes, saw personal income tax revenue decline by 19.1 percent. Alaska Gov. Sean Parnell, R, signed a bill that cut taxes on oil companies, cutting corporate tax collections by half.
While income taxes are generated up to a year in advance, state budget analysts said the winter weather is to blame for a dramatic slowdown in growth of sales tax revenues. States reported a 1 percent increase in sales tax revenue in the first quarter, the lowest growth rate since the first quarter of 2010. Eleven states saw a drop in sales tax revenue year-over-year.
Lucy Dadayan, a senior policy analyst at the Rockefeller Institute, said sales taxes fell in Arizona by 16.7 percent after a temporary 1-cent sales tax expired. Other states hit hard by wave after wave of Polar Vortex, like Maryland, New Jersey, Georgia and South Carolina, also saw a drop-off in sales tax collection.