A recent report by the State Budget Crisis Task Force chaired by former Federal Reserve Chairman Paul Volcker and former New York Lt. Gov. Richard Ravitch (D) outlined six threats to fiscal sustainability in the states. Cue the calls for more austerity! However, as other recent reports have shown, fiscal austerity at the state level harms middle class and low-income families, drives job losses, and continues to severely hinder the economic recovery.
Progressive state lawmakers have been advancing smart, effective policies to take on what the authors of the State Budget Crisis Task Force report accurately describe as the structural problems facing states in the coming years. Here are five solutions that your state can advance to help avert fiscal crisis while promoting economic growth, fairness, and equality:
1) Redesign and Strengthen Medicaid : The first problem the State Budget Crisis Task Force report identifies is that the cost of Medicaid is growing faster than inflation. This is a result of the fact that health care costs are growing faster than inflation and that more families are temporarily relying on Medicaid due to the economic downturn.
North Carolina addressed the growing cost of Medicaid over a decade ago by implementing a coordinated care model called Primary Care Medical Homes. In this model, regional networks of physicians, nurses, pharmacists, hospitals, health departments, and community organizations work together to provide cooperate, coordinated care to patients. Each patient is matched with a primary care physician who leads the health care team to ensure that the patient’s health needs are effectively addressed. By reducing hospitalizations and emergency department visits and better managing chronic illnesses, the model has saved North Carolina hundreds of millions of dollars every year. North Carolina State Representative Verla Insko explains, “not only has it saved our state $1.5 billion over three years, it has improved the health outcomes of the families that rely on this program. This is about our core values. We refused to choose between saving money and quality of care.”
Other states can follow North Carolina’s lead. Recently, Oregon adopted a law to do just that at the urging of Governor Kitzhaber, a former emergency department doctor.
2) Require Online Retailers to Collect Sales Taxes : Faced with federal budget deficits caused in part by massive tax breaks for the wealthy, Congress is reducing spending. Instead of letting the tax cuts for the wealthiest 2 percent of Americans expire, Congress passed the buck by cutting state funding, creating fiscal crises at the state level.
State reliance on federal funding has intensified as state revenue collections have declined. A major reason for that decline has been the prevalence of online shopping. Current law prohibits states from collecting sales tax for online purchases unless the vendor has a physical presence in the state. But why don’t you pay sales tax on barnesandnoble.com when Barnes and Noble has several brick-and-mortar stores in your state? To avoid sales tax collection, online versions of stores have incorporated separately.
As a result of online shopping and corporate tax avoidance strategies, state sales tax collection has declined drastically. Congress can and should fix this by authorizing states to collect sales tax from all online purchases. In the meantime, states have been taking the lead in requiring companies with physical presences in the state to collect state sales taxes. As California State Sen. Loni Hancock put it last year as a compromise was passed in that state that required Amazon to begin collecting sales taxes starting this September, what is at stake is whether online retailers care about “the people whose lives are affected by whether or not we have enough money for schools and roads and to keep the libraries and parks open.”
3) Increase Pension Contributions and Prevent Pension Abuses: Facing budget deficits, some states have chosen to inadequately fund pension obligations rather than adopt solutions for long-term financial sustainability. But a little known fact is that many state employees are not eligible for Social Security, which is only mandatory outside of the public sector. For this reason, the solvency of state employee pensions is critical not only to states but also to the retirement security of cops, firefighters, and teachers.
States can do two things to fully fund their pension obligations. First, states should slightly increase pension contributions to 5 percent of their budgets (compared with the present level of 3.8 percent), as recommended in a recentreport  by the Center on Budget and Policy Priorities. Second, even though individual abuses are not the predominant cause of underfunded state pension funds, states can also change their rules to prevent such abuses, including “double-dipping” (where a person draws a pension while also receiving a government salary) and “spiking” (where a person artificially inflates their final year’s earnings in order to increase their pension).
4) Rely Less on Sales Taxes, More on Progressive Individual Income Taxes: As the Task Force report highlights, there have been tectonic shifts in our economy that have eroded tax collection. Sales taxes are typically levied on goods purchased from brick-and-mortar stores, and the growth of online shopping and the shift toward a service-based (not goods-based) economy have led to severely decreased sales tax collection.
The economic downturn compounded this even further. Sales tax collection is extremely volatile, unlike income taxation. During an economic downturn, a 5 percent decrease in employment would typically result in a similar decrease in income tax collection. However everyone — even those with jobs — cuts spending out of fear. As a result, the drop in sales tax revenue during and after a recession is dramatic. States rely on sales tax for nearly one third of their revenue and on personal income tax for another third. States would experience less volatility and increase revenue collection by reforming their tax systems to rely less on sales taxes and more on progressive income taxes.
Making state tax systems more progressive would help raise the revenue to pay for needed public services that can help save jobs and power state economies through a recession. Nearly everyone agrees that the wealthiest families should pay at a tax rate at least equal to what low- and middle-income families pay. Yet in almost every state, they pay less. Our states can get on track for long term fiscal sustainability if they reform income taxes to ensure that when all taxes are taken into consideration – sales tax, property tax, and income tax – the wealthiest are paying their fair share. Many states have considered and enacted taxes on high-income earners to prevent job-killing cuts in services. As Maryland State Sen. Roger Manno described the ultimately successful effort in his state to pass a more progressive income tax structure this year, the goal should be a “broad based, pragmatic, fair and palatable revenue solution that offsets cuts to education and social services which would be more than any of us could bear.”
5) Lose the Gimmicks and Make State Taxes More Equitable: Unlike the federal government, states are required to balance their budgets every year. During economic downturns, states must either raise revenue or cut funding for public services (such as schools and police), or both. All of these options are difficult political decisions. To avoid this, many states have used budget gimmicks – such as selling off state assets to pay to close just one year’s budget gap – to delay budget crises rather than solve them.
Rather than cut funding for schools, police, fire departments, and other important public services, states must reform tax systems. As law professor David Brunori at George Washington University Law School puts it, “A tax system must not only raise enough revenue to fund the programs demanded by the citizens, like all aspects of government, it must be fair and equitable.”
Loopholes used by wealthy and large corporations are serious threats to equality and fairness in our tax system. State tax codes are full of special deals for powerful interests that need to be overhauled so everyone plays by the same rules. When the deck is stacked in favor of politicians’ wealthy campaign contributors and corporate interests, the middle class gets stuck with the consequences. Closing the numerous corporate loopholes can help raise hundreds of millions of dollars for each state budget (billions for the most populous states), put states back on track for fiscal sustainability, and make the tax system more equitable for everyone.
As budget debates play out in the states, politicians will be proposing their answers to the problems that threaten the financial sustainability of state budgets. The kinds of solutions they call for will reflect their values, whose interests they are working for, and how equitable our society will be in the future.