MarianVejcik
By Stephen Cowie
Increasing risks of an economic slowdown or recession are likely to have a negative impact on the largest state revenue sources.
The financial position of most states in fiscal 2022 was favorable in the aftermath of significant federal aid due to the pandemic, as well as tax receipts that exceeded budgeted expectations.
Despite this positive trend, we believe state finances have likely peaked due to growing evidence of an economic slowdown. A hawkish Federal Reserve, which is expected to continue increasing interest rates, is likely to have a negative impact on both personal and corporate spending.
If this leads to significant economic slowing, that could decrease consumption and increase unemployment. As per the Tax Policy Center, for fiscal 2023, personal income tax collections are expected to increase 0.4%, with corporate income tax revenues declining by 8.6% and sales tax revenues only growing by 1.9%. As such, prudent state budgetary assumptions for fiscal 2023 are likely to be even more important as states plan for a slowing economy.
Current tax receipt trends are already raising concerns for some states. California, with approximately two-thirds of the state’s revenues coming from personal income tax receipts, is already seeing evidence of a financial slowdown as fiscal 2023 begins.
For the month of July, its first month of the new fiscal year, total revenues underperformed budgetary expectations by 12% and largely reflected a slowdown in the high-paying technology industry that will have a negative impact on personal income tax receipts.
The state’s legislative advisor is already projecting that the state’s three largest tax sources are likely to underperform forecasts for the current fiscal year. Other states are also experiencing declines in revenue sources. New York State has reported a 3.2% decline in personal income tax receipts from the beginning of its fiscal year in April through July.
Looking ahead, we believe a slowing – as opposed to a sharp drop – in state revenues is the likely course over the next several months. However, the duration and magnitude of this trend is uncertain, and will likely depend on many variables, including inflation expectations, actions by the Fed, personal spending and overall consumer sentiment.
While built-up “rainy day” reserve fund balances during stronger economic environments can help if revenues underperform, this liquidity source could diminish and limit state flexibility. As such, more challenging days are likely ahead for states as peak financial conditions have likely already occurred.
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