Increased Reliance on the Sales Tax Leads to Many States’ Budget Challenges

An article in Governing highlights some of the budget challenges states may face when they cut income taxes and increase sales taxes to generate revenue.

As states have recovered from the recession, seven cut individual income taxes (and increased sales taxes). Others, on the other hand, increased their sales tax after income tax cuts resulted in too little revenue.

This trend means that states are relying on the sales tax more than ever before. However, the sales tax usually constitutes a small portion of a state’s revenues.

The sales tax is less volatile than the income tax, which means it can be easier to forecast accurately from year to year. But it’s regressive, meaning it hurts lower-income earners a lot more than it impacts rich people. And as the economy moves toward technology and services (things that are difficult to tax), the sales tax base is capturing an increasingly smaller piece of what consumers are actually spending. Finally, sales tax revenue as a whole is growing slower than personal income.

The biggest problem with this shift, according to the Urban Institute report, is that the anemic growth on states’ revenue side of the ledger is countered with rising costs on the expenditure side. In other words, revenues won’t keep up with state spending. This is true despite the fact that every state has also cut expenditure growth to below historic levels.