State and Local Fiscal Trends and Future Threats

1. State and Local Fiscal Trends and Future Threats A Report Prepared for National Association of Realtors By State and Local Fiscal Policy Research Program Institute for Policy Studies George Washington University Presentation to the Connecticut Legislative Program Review and Investigations Committee October 26, 2005

2. Objectives 1. Review state and local revenue raising and spending patterns and changes from 1992 to 2002 2. Identify trends impacting state and local revenue raising efforts and spending needs

3. Revenue Raising and Spending Patterns and Trends, 1992-2002 • Extent of centralization of revenue raising and spending responsibilities • Size of the public sector • Revenue mix • Spending mix

4. Revenue and Expenditure Centralization Patterns and Trends 1. In 2002 states raised 55% of state/local own revenues. Same as 1992. 2. In 2002 states accounted for 50% of direct expenditures, up from 49% in 1992. 3. No change in patterns or trends, but variation across states.

7. Size of Public Sector:Per Capita Own-Source Revenues

8. Size of the Public Sector: Trends in State and Local Revenues From 1992 to 2002 real per capita state • total general revenues increased 22.5 percent • own-source revenues increased 16.3 percent, • tax revenues increased 13.5 percent, • income taxes increased 24.2 percent, • current charges increased 32.4 percent • Intergovernmental revenues increased 38.6 percent

9. Percent of Federal Grants in Aid to State and Local Governments by Function 1972 1982 1992 2002 2006 est. Nat. Res. And Environment 2.2 5.5 2.2 1.4 1.4 Transportation 14.7 13.7 11.5 11.7 10.7 Education 27.6 18.4 14.8 12.8 13.2 Health 17.5 21.4 40.1 45.1 48.0 Medicaid 13.4 19.7 38.1 42.0 44.2 Income Support 26.3 25.3 25.8 23.2 21.0 All Other 11.7 15.7 5.6 5.8 5.8

10. Public Sector Size:Revenues as a Percent of Personal Income

11. Public Sector Size:Per Capita S/L Direct General Spending

12. Public Sector Size (Continued) From 1992 to 2002, real per capita state direct general expenditures • declined in one state – New Hampshire • increased by less than 10 percent in six other states – Alaska, Arizona, Hawaii, Nevada, New Jersey and Rhode Island • Increased by more than 40 percent in ten states. • Increased by 31.2 percent in Connecticut while the U.S. average was 27.6 percent

13. Public Sector Size: Real Per Capita Spending From 1992 to 2002, real per capita state spending • On public safety increased 38.0 percent • On education increased 31.6 percent • On social services increased 27.8 percent • On transportation increased 22.9 percent

14. Revenue Mix • State governments rely more heavily on own-source revenues and tax revenues than local governments • State governments rely more heavily on sales and income taxes while local governments depend on property taxes and current charges more • State and local reliance on own-source and tax revenues declined from 1992 to 2002

18. Expenditure Mix • State governments spend more heavily on intergovernmental transfers (28.5%), social services and income support (24.4%), and contributions to insurance trusts (11.5%). • Local governments spend more heavily on education (38.7%). They also allocate a greater share of their budget for public safety and housing.

20. Two Issues Related to State and Local Fiscal Policies • A Balanced Tax System • State and Local Fiscal Policies and Economic Growth and Development

21. A Balanced Tax System • What does it mean to have a balanced tax system? • Advisory Commission on Intergovernmental Relations • Balance among characteristics of a sound tax system

22. Balance in State-Local Tax Systems, 2002 Strongly Balanced 4 Fairly Balanced 14 Poorly Balanced 22 Imbalanced 11

23. Defining Local Economic Growth and Development • Economic growth implies growth in various measures of economic output – income, jobs, etc. • Economic development implies more than just increases in measures of economic outputs. It implies that the welfare of citizens is improving – poverty rate, infant mortality rate, etc..

24. Factors Influencing Local Economic Growth and Development • Primary engine for strong state and local economies is a strong private sector • Agglomeration economies • Human capital and labor costs • Access to markets and raw materials • Natural endowments/amenities • Strong educational system • State and local fiscal policies

25. State and Local Fiscal Policy and Local Economic Growth and Development • Traditional fiscal policies targeted at attracting new firms and expanding existing businesses – targeted tax credits, job training, and other targeted assistance programs. • Policies promoting internal growth by supporting entrepreneurship and creating an environment conducive to private economic activity.

26. Taxes and Economic Activity • Several studies find that taxes, at the margin, may have an incremental negative impact on economic activity • In this view, cutting taxes can promote economic activity • But the empirical results assume everything else remains the same – no cut in services, no changes in fiscal behavior of other state or local governments • Cutting taxes and cutting services will be detrimental to economic activity

27. Spending and Economic Activity • Several studies conclude that the level and quality of public services available is a major influence on promoting economic activity – especially infrastructure and educational services • If cutting taxes reduces the level and quality of services available it will have a detrimental impact on economic activity

28. Summary of Trends Impacting State and Local Fiscal Policies Trend State/Local Revenues State/Local Expenditures Erosion of trust in government Undermines ability of government to raise funds through general taxes Federal Mandates Unfunded mandates put pressure on state and local spending, especially in the area of health care and homeland security Federal Tax Policies Undermines state (and to lesser extent local) efforts to raise taxes, especially income and sales taxes, and is forcing states to decouple from federal government

29. Federal Intergovernmental Grants Shifting emphasis toward Medicaid while all other aid categories decline in relative importance Demographic Changes Undermines ability of state and local governments to raise tax revenues – especially income, sales and property taxes Puts added pressure on state and local spending – particularly health related categories, but other categories as well Technological Change Undermines state and local efforts to raise revenue from sales and income taxes, as well as the local property tax E-commerce Undermines state and local governments ability to raise revenues from sales taxes

30. Interjurisdictional Competition Puts pressure on state and local governments to keep taxes low Puts pressure on state and local governments to keep spending low, except maybe for infrastructure services vital to economic growth like education and transportation Targeted Tax Incentives Undermines ability to raise local taxes, especially the property tax Globalization Undermines ability of state and local governments to raise taxes Puts pressure on expenditures, especially in infrastructure services needed to compete with other jurisdictions School Finance Reform Undermines legitimacy and acceptance of local property taxes Can lead to declining quality of education services