The changing realities of a state’s economy can create headaches on a state’s balance sheet. Several states across the nation are experiencing what is known as base erosion: the gradual decline of industries, businesses or sectors upon which states depend for tax revenue. Over the last fifty years, as America transitioned from a manufacturing economy to services and customer goods, tax policy had to tap new sources of revenue as plants closed. More nimble states have changed their tax policy over time to reflect underlying economic changes, while others have relied on a more static tax policy and thus risk the financial health and creditworthiness of their state. This blog post takes a look at three states experiencing base erosion and the various effects it has on those areas.
Honey, I Shrunk the Income Tax Base
Georgia could be the poster child for the concept of base erosion. In the 1950s, Georgia was a manufacturing powerhouse, making everything from cars to kitchen appliances. However, Georgia has been experiencing a steep decline in manufacturing employment, while employment in the services, health and education sectors has been growing as a report from the Fiscal Research Center notes. Georgia has not kept pace with these changes and faces growing budget deficits year-over-year, and in 2015 was ranked 50th in revenue from domestic state sources. The Fiscal Research Center report suggests tapping e-commerce and new types of goods and services, such as Uber and Lyft, to replace the growing hole in the tax base. Other proposals to widen the tax base include creating a broad $25 minimum tax on all Georgia residents, indexing brackets to inflation and a capital gains tax. Tax reform in this area, however, may prove untenable, according to the Georgia Public Policy Foundation, a nonpartisan research institute focusing on the economics of public policy.
Instability in Oil Markets
States which rely on the oil and gas industry have been hit particularly hard. Between the October 2015 and February 2016, oil prices fell almost 80 percent. They have since climbed to about 40 percent of their peak. Oil prices are directly linked to the number of drilling operations carried on in a state, supporting thousands of jobs in oil and gas and related industries. The loss of this business has eroded the taxable base in America and around the globe.
Texas, known as a large oil and gas extracting and processing state, has fared relatively well despite severe global instability. This was not always the case. When oil prices fell to $10 in the late ‘80s, former boomtowns turned bust, tightening state budgets dramatically. Today, Texas’s state government and various localities have paid off their debts and invested in other more stable industries, such as health care and infrastructure. These actions have softened the blow of falling oil prices, and Texas was recently ranked the 16th healthiest state in terms of finances in the country.
Oklahoma’s economy, however, relies on a healthy mining industry as the state’s largest private sector as a percent of GDP. As oil prices fell, rigs remained operational but miners were laid off resulting predictably in state budget shortfalls. In December 2015, the state announced a “revenue failure.” Tax revenue was $50.1 million below what was budgeted, mainly due to slowing oil activity. The state then announced in 2016 that the FY 2017 budget hole was projected at $1.3 billion, 15.9 percent for the projection for the previous fiscal year. Revenue from the personal income tax is projected to fall by close to $150 million in 2017, forcing lawmakers to rethink automatic income tax rates cuts planned for this year. The budget crisis caused by erosion of several different tax bases has triggered automatic spending cuts, which has led to layoffs and decreased funding for many of the state agencies.
State tax policy will continue to come to the fore in an everchanging economic landscape. As jobs are lost to automation and oil markets fluctuate, states must replace revenue that is lost by tapping new sources.
Check in next week for an interview with the Tax Foundation, a nonpartisan tax research group, on base erosion issues facing the states.
Continue the discussion on the BBNA State Tax Group on LinkedIn: Should states expand their revenue base or increase tax rates to make up lost revenue?
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