Why Those New State Budget Surpluses May Not Last

By Mark Koba

June 20 (CNBC) — State coffers are building back up—some with record surpluses.

But experts warn that reduced tax revenues— along with a return to overspending—could jerk states right back into the red, and quickly.

“Some of the states’ deficit reduction is coming from economic growth, but most of it is coming from taxes,” said Elizabeth McNichol of the Center on Budget and Policy Priorities. McNichol authored a study this month on state revenue increases.

The increased revenues came about because many taxpayers front-loaded income into 2012 rather than 2013 in an effort to steer clear of tax plans mandated on the Congressional level, according to McNichol.

The danger for states is getting to depend on those revenues.

“While those taxes filled state budgets at least for now. there’s no guarantee they will be there in the future,” said McNichol.

“And with cutbacks in funding from the federal government and a slower economy, that could leave states high and dry if they squander surpluses on new government programs or premature tax cuts,” she said. “They could be back where they started.”

Disappearing Deficits

U.S. state budgets suffered their worst downturn in 70 years from the Great Recession, according to the CPBB. More than half the states had deficits.

But many budget declines are evaporating, if not completely disappearing.

In the midst of an energy and agricultural boom, North Dakota is projecting a $1.6 billion surplus over its two-year budgeting cycle. Texas projects an $8.8 billion surplus over its current two-year budget cycle.

Florida, forced to make deep spending cuts in recent years, projects a $437 million surplus. Ohio expects a surplus of $1 billion, and Iowa a $484 million surplus, according to the National Association of State Budget Officers.

The biggest turnaround may be in California. The Democratically controlled state legislature in Sacramento just approved a $96.3 billion budget, the third largest in state history, based on a projected surplus of nearly $4.4 billion. Only three years ago, California was running a $60 billion deficit.

Much of the credit for the surplus in the Golden State—coupled with spending cuts—goes to a tax increase voted on by California voters last November that ranged from 9.3 percent to 10.3 percent for individuals making $250,000 to 10.3 percent to 13.3 percent for those making at least $1 million annually.

Resisting the Urge to Squander

It’s not just California seeing higher taxes turn to healthier budgets. In the fourth quarter of 2012, according to the Nelson A. Rockefeller Institute of Government, all state tax receipts were up 5.7 percent from the fourth quarter of 2011.

The CPBB reports that the typical state has collected 8.9 percent more in personal income taxes so far this year than in the same period in 2012. Seven states Florida, Texas, Nevada, Washington, South Dakota, Wyoming and Alaska, don’t have a personal income tax.

But states are in danger of reversing their progress if they spend now or try turning surpluses into tax cuts.

“States have to work on a careful balance when it comes to taxes,” said Stanley Veliotis, a tax professor at Fordham University.

“On the one hand, they can’t raise taxes too high and force businesses and people to move to states with less taxes,” Veliotis explained. “On the other hand they can’t lower taxes too much and lose out on revenue.”

Some states are using their new found money to restore cuts in education and infrastructure—Florida is looking to increase teacher pay, and Tennessee is expected to spend more on health care and its prison system.

California is putting some of its money away for a rainy day fund besides increased spending on education and healthcare.

Others, like Ohio, Iowa and Indiana have lawmakers pushing for state tax cuts.

“States are thinking about cuts, but I think they need to wait and see whether economic growth can continue,” said McNichol. “It doesn’t make sense to cut taxes now if they’re such a main source of revenue.”