Free-Market Reforms Key to States’ Recovery

Published January 16, 2015

Half a decade after the U.S. economy fell into a recession, 41 states’ tax revenues in the third quarter of Fiscal Year 2014 were higher than in the third quarter of Fiscal Year 2013            .

However, 16 states, including some of those states with higher tax revenues, are projecting budget shortfalls within the next two years.

Although the details of each state’s situation vary, the solution most often suggested to close the budget gap is tax hikes. Other states are planning to raid their “rainy day funds” to buy some time.

A History of Underperforming

In addition to present budget shortfalls, Heritage Foundation Research Associate Joel Griffith says the economies of tax-hiking states have historically lagged behind tax-cutting states.

“States implementing new income taxes over the past 50 years have seen population decline gross state product decline and revenue decline, in relation to the other states,” he said.

“States such as California, Connecticut, Delaware, Illinois, and Maryland, hiked taxes following the Great Recession. Overall, these states underperformed when compared to long-time low-tax, business-friendly states such as Texas and Utah.”

Opportunities for Reform

Nicole Kaeding, a budget analyst for the Cato Institute, says those underperforming states should use the opportunity to make real tax and spending policies. 

“The shortfalls present an opportunity for states to cut spending, reform programs, and eliminate waste and duplication. These actions, when taken together, can put a state on a firmer fiscal footing,” she said.

Kaeding said economic growth—and, by extension, tax revenue growth—is promoted through free-market policies, not economic development plans written by the government.

Winning Solutions

“Economic growth doesn’t come from providing grants or handouts to corporations; it comes from fostering a pro-growth environment,” she said. “A pro-growth environment is one with limited government intervention. It’s an environment where businesses and individuals are able to make the best decisions in their lives with minimal interference from government.

“That means low levels of spending and regulation. It also means a tax code that has low rates, and is neutral, meaning that it doesn’t advantage one group over another,” she explained.

Another key to filling budget holes, Kaeding says, is reducing tax rates.

“When state budgets became tight during and immediately following the Great Recession, many states resorted to tax increases to close budget gaps. Their experience demonstrates that this is the wrong approach,” she said. “States didn’t solve the underlying structural issues to state budgets, which is why they are still dealing with shortfall issues. All that tax increases did was kick the problem several years into the future.” 

Matt Hurley ([email protected]) writes from Cincinnati, Ohio.


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