Cyclical Variability in State Government Revenue

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1. Introduction

During recessions, the slowdown in economic activity tends to significantly reduce state tax revenue growth, making it difficult for states to fund their existing programs. Compounding the problem is the fact that the demand for state government expenditures tends to increase during a recession. This is particularly true for programs such as unemployment insurance, welfare, and higher education. Because of this inherent mistiming between revenue flows and expenditure flows, states generally find themselves experiencing a self-proclaimed fiscal crisis during each and every recessionary period. In this regard, the most recent recession to start off the 21st century was no different than the previous recessions of 1990-91 and 1980-82. In terms of its impact on state tax revenue, the most recent recession has been more severe than the 1990-91 recession, but somewhat less severe than the 1980-82 recession. For the second quarter of 2002, for example, state tax collections (adjusted for inflation) were down 7.1 percent from the same quarter of the previous year.¹ This has been a somewhat harsh adjustment for many states after experiencing almost a decade of steady positive revenue growth.

There are only two possible ways a state may ease the fiscal stress it faces during recessions: (1) reduce the cyclical variability of its revenue stream; or (2) build savings during booms to inject during recessions (create and properly use a rainy day fund). In this report, we focus on the first of these two options—the possibility of reforming a state's tax structure in an attempt to reduce the variability of the revenue stream.

Notes from this Section

1. Data from Quarterly Summary of State and Local Tax Revenue, U.S. Bureau of the Census, http://www.census.gov/govs/www/qtax.html.

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