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Reason Foundation

State Budget Crises Arrive Like Clockwork

Lawmakers once again turn to cigarette taxes to balance their budgets

Michael Flynn
February 11, 2009

Three weeks ago President Barack Obama entered the history books and the White House, riding a promise to change the way Washington works and to inject new ideas into stale policy debates. It is too soon to tell whether he'll succeed in changing DC, but here's hoping this mandate for change gets heard in the nation's state capitals.

From Albany to Sacramento, America's governors and state legislators are showing that there's nothing like that "old-time religion." Change may be in vogue among voters, but their elected representatives in state government are like that old vaudeville troop that can't let go of its old laugh lines.

The skit this year, of course, is another "budget crisis." In states across the country, the public is being told that parks will close, workers will be furloughed and, in California, IOUs instead of tax refunds will be mailed to taxpayers. The Center for Budget Policies and Priorities warns that "at least 39 states have made or proposed budget cuts that threaten vital services" and face total deficits of $350 billion over the next couple years. Other research organizations report deficits less than a third of that, but are still quite concerned.

The bipartisan National Conference of State Legislatures says state budget figures are "absolutely alarming, both in their magnitude and the painful decisions they present to state lawmakers."

Do these sky-is-falling state budget forecasts sound familiar? They should.

In 2002, the National Governors Association issued a press release saying that "states face the most dire fiscal situation since World War II." In 1990, The New York Times reported that states and cities faced a "fiscal calamity." Fire up Google, pick almost any year and you'll find lots of stories about a "fiscal crisis" in the states.

For decades states have been on a predictable schedule. In good economic times, they collect a lot more tax revenue than they really need. But instead of giving the money back to taxpayers or putting it into a rainy-day fund, they pretend the good times will never end and they spend it. When the good times do end, they plead poverty and either ask the federal government for help or raise taxes on their beleaguered citizens. Eventually, the economy rebounds and the vicious cycle starts again.

Look at the boom years preceding this recession. State general fund revenue increased twice as fast as inflation. In the five years between 2002 and 2007, revenues grew so much that state governments collected almost $600 billion more than if revenues had just kept pace with inflation. Had they been responsible, they could have maintained all state services, increased spending to compensate for inflation and population growth, and enacted a half-trillion dollar tax cut.

Instead, lawmakers ploughed the windfall into new spending. From 2002 to 2007, overall spending rose 50 percent faster than inflation. Education spending increased almost 70 percent faster than inflation, even though the relative school-age population was falling. Medicaid and salaries for state workers rose almost twice as fast as inflation.

Unfortunately for taxpayers, this money is gone or is now built into ever-expanding baseline spending. So, state lawmakers are once again sounding the alarm about a budget crisis that they ‘just couldn't have seen coming.' And, they've again reached into their old bag of tricks and warned about closing parks, cutting back on services and laying off teacher, firefighters and other state workers. It's as if the last dollar the government spends each year is to keep a park open.

Desperate for an infusion of cash, politicians have turned to their oldest stand-by; cigarette taxes. Even after decades of steady increases in tobacco taxes, state lawmakers in at least a dozen states are looking to raise cigarette taxes.

Right now, government makes more off the sale of a pack of cigarettes than tobacco companies. In some states, two-thirds of the price of a pack already goes to government. This will get worse because Congress just hiked the federal cigarette tax 61 cents a pack to help pay for the expanded State Children's Health Insurance Program.

The overwhelming majority of cigarette taxes are paid by low-income households. In a recession, you'd think lawmakers would want to give these folks a break. But, lawmakers' habits are hard to break even when it is clear that tax increases don't raise any new revenue.

In 2006, New Jersey raised its already high cigarette tax, thinking it would bring in an extra $30 million a year. It didn't. Worse, it caused their actual collections to drop by more than $20 million. The tax increase threw the state's budget off by $50 million, money that had to be made up by other taxpayers. This isn't unique to the Garden State. Since 2003, there have been 57 cigarette tax increases across the country. In 37 (68 percent) of those cases revenues failed to meet projections.

Isn't it time we retired this skit? We're almost one decade through the 21st century and our esteemed lawmakers in state capitals are still using a decades-old recipe: Boom and bust budgets; cigarette taxes when times get tough. Stir.

It seems our state lawmakers have reached their "sell-by" date.


Michael Flynn is Director of Government Affairs


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