'Perpetual fiscal crisis' for states?

• Author: Peirce, Neal R.
• Position: Commentary - Brief Article

Could it be true that the $40 billion worth of budget deficits the governors and state legislatures now face aren't temporary? That the red ink will keep flowing even when the recession ends? That without some major system corrections, our state governments are headed for "perpetual fiscal crisis?"

That alarming prognosis comes from no less a figure than Ray Scheppach, respected economist and veteran executive director of the National Governors Association, which held its annual midyear meeting in Washington the last weekend of February.

Scheppach notes the cumulative deficits, reported from the 41 states that are currently running in the red, are twice the total figure in the last recession in the early 1990s. California's shortfall is estimated at a staggering $12.4 billion. In New York, the current deficit is $3 billion. In New Jersey, it is $2.4 billion; Michigan, $1.4 billion; Massachusetts, $1.35 billion; Virginia and Florida, $1.3 billion each.

States have no choice: They have to balance their budgets. Anxious to avoid tax hikes, especially in an election year, it's clear they'll look first to cuts, including secondary and higher education, transportation, and the health and welfare programs critical to the poorest Americans.

But why won't solvency return when the current recession--apparently a fairly light one--goes away?

That's where the painful Scheppach formula comes into play.

First, he notes, the states have a deteriorating tax base-one built for the manufacturing economy of the 1950s, "not the high technology, international, and service--oriented economy of the 21st century." State tax systems focus heavily on taxing goods but exempt most services--even though services, from legal and accounting to real estate and information technology, are "where the action is in today's economy." That failure is amplified by growing numbers of transactions--especially business-to-business--conducted over the Internet on an interstate basis and effectively tax free.

The ideal sales tax, says Scheppach, has a low rate on a broad base. Right now we have the opposite--rising rates on an artificially limited base.

And corporations, he adds, have exploited countless loopholes to get around state taxes. Many take their profits offshore or into states with no or very low taxes on profits.

That leaves income taxes--the one way left to capture practically all economic activity (and in equitable ways). But states' income tax yields have dipped...