Josh Barro of Manhattan Institute has a strong column at RealClearMarkets digging more deeply into the Rockefeller Institute’s report on quarterly state tax collections.  Key take-away: “states without income taxes are generally showing admirable (and unsurprising) revenue stability.”

Josh continues:

More surprising, but ultimately logical, are the results from states with flat income taxes. The usual expectation is that flat taxes will produce more stable revenues than progressive income taxes that rely disproportionately on high earners. This is because high income people tend to have volatile incomes that move sharply with overall economic performance.

However, five of the seven states with flat taxes saw income tax revenue drops above the 11.4% national average. While Pennsylvania and Utah outperformed most states with drops under 9%, Indiana’s flat tax saw a 20.3% drop in collections, and the four others ranged from 11.7% to 14.3%. Meanwhile, New York and New Jersey (which have graduated income taxes that rely heavily on high-income taxpayers) saw revenue drops under 9%.

Progressives will point to these results as evidence that graduated taxes do not promote revenue instability. They are wrong. What has happened is that states with flat income taxes have resisted political impulses to raise income taxes. Meanwhile, states with sharply graduated taxes have tended to impose (often sharp) income tax hikes for the current fiscal year. If states like New York and New Jersey hadn’t raised taxes, their revenue performance would be among the worst in the country.

These tax trends, which provide a slightly lagging reflection of the recession’s severity around the country, also raise a key question about the sustainability of state fiscal recoveries starting in 2010.

Putting aside that extreme basket case on the Left Coast, perhaps the best bellwethers of sharply different fiscal approaches are Indiana and New York.

Indiana Gov. Mitch Daniels avoided an income tax hike this year and, as a result, is coping with one of the nation’s biggest third-quarter drops in tax collections.  Daniels has made it clear he intends to balance his budget on the spending side, including a recently announced freeze on state employee pay.

New York, by contrast, sought to avoid a large drop in PIT collections in the current fiscal year only by sharply raising marginal rates, which will increase the state’s dependence on a volatile (and mobile) segment of tax base in the crucial two years ahead.  Relying on tax hikes and temporary federal stimulus funds, the Empire State did little to slow spending growth in fiscal 2009-10, and the Legislature is still resisting Governor David Paterson’s call for mid-year deficit reduction actions to cope with a shortfall that developed in part because the PIT increase raised less than expected.

Which state will have the strongest and most sustainable recovery–fiscally and economically?  Put your money on those Hoosiers.

P.S. — Josh also provides a corrective for a key statistic in my post yesterday.  He says a total of eight states raised income taxes this year: Connecticut, California, Delaware, Hawaii, New Jersey, New York, Oregon and Wisconsin.  (Maryland increased its PIT last year.)

About the Author

E.J. McMahon

Edmund J. McMahon is Empire Center's founder and a senior fellow.

Read more by E.J. McMahon

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