Tax Cuts Could Come Back to Haunt State Retirement Systems

Although state retirement systems have made a strong recovery from the Great Recession to reduce once-yawning funding gaps, years of tax cuts could come back to haunt states and force them to reduce retirement benefits. That’s according to a report from the National Conference on Public Employee Retirement Systems (NCPERS).

NCPERS is urging state governments to close tax loopholes and end “irresponsible corporate subsidies” before another recession strikes to avoid cutting state services and public employees’ retirement benefits.

“With the US economy now 10 years into an economic expansion, it’s not a question of if, but when, we will face another recession,” Hank Kim, executive director and counsel of NCPERS, said in a statement. “State governments have an immediate opening to improve their revenue structures and need to act decisively.”

The report said Americans’ personal income, adjusted for inflation, rose 24% from the end of the Great Recession in mid-2009 to the last quarter of 2018. Real tax revenues collected by the states, however, were only 13.4% above where they were during the third quarter of 2008, their pre-recession peak.

“Meeting future pension plan obligations and commitments to other public services will be much easier if states have an adequate and growing tax revenue structure,” said the report.

Part of the declining share of state tax revenues as a share of income is attributed to legislated tax changes, said the report. According to the National Council of State Legislatures (NCSL) states cut taxes each year from 1995 to 2000, a period of strong economic growth with the GDP growth averaging 4.3%.

But the US was hit by a recession in 2001, which was followed by six years in which the GDP growth averaged just 2.7%. From 2001 to 2009, states enacted tax increases, mostly through sales taxes. In 2010, the first year of recovery, there were large increases in numerous taxes and fees, and since then, legislated tax changes have been small, and the enacted changes tended to be sales tax increases.

NCPERS expects another recession could hit the economy at some point over the next decade.

“When that happens, the states’ ability to meet their financial commitments, such as public pensions, will depend on those states having sufficient revenues to fulfill these commitments,” said the report. “When tax revenues tighten, as they do in recessions, the competition for general fund dollars will become even more intense, and public pensions will face greater challenges in obtaining the funding to meet any budgetary gaps.”

The report outlined several principles for making state tax systems stronger, more resilient, and fairer for both current and future taxpayers:

Avoid tax cuts and other legislative actions that reduce tax revenues.
Tax cuts and tax incentives aimed at attracting businesses and jobs rarely work as advertised.
Reverse previous tax cuts. Major tax increases are never easy, but the easiest tax to raise is probably one that was recently cut.
Increase reliance on personal income tax. Personal income tax has the capability to grow at least as fast as the growth in the income of state residents.
Minimize dependence on sales and other consumption taxes. Sales taxes are regressive, meaning they fall harder on low-income taxpayers, and the revenues tend to diminish over time.
Be wary of exotic revenue sources such as lotteries and gambling, casinos, which tend to displace existing revenues.
Require all tax breaks to expire after some set period.