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State Tax Revenues Slowly Rebound

State governments are climbing out of the deep fiscal hole they fell into during the economic downturn, but the pace of the recovery is expected to slow as federal budget cuts kick in and a valuable tax windfall disappears, according to a new report.

The Fiscal Survey of States found that the fiscal distress that gripped states in the years following the recession has largely eased. The report, to be released today, said 30 states are on course to enjoy budget surpluses and 10 others are right on target with revenue.

Meanwhile, 42 governors proposed budgets that increased spending for next year, and many states can begin restoring money to key programs, including public schools, that they were forced to cut in recent years.

But the report warned that the fiscal future is uncertain. Analysts are still waiting for states to feel the full impact of the across-the-board federal budget cuts that went into effect earlier this year. Also, while improving, unemployment remains high, creating a drag on revenue while elevating social service spending.

State sales tax revenue is still growing slowly, in large part because levies associated with online sales often go uncollected, the report said. A bill that would authorize states to collect taxes on all Internet purchases has passed the Senate and is now in the House, where its prospects are unclear.

“On the surface, things are getting better for states, but the improvement is slow and there are some significant challenges ahead,” said Dan Crippen, executive director of the National Governors Association, which authored the report in conjunction with the National Association of State Budget Officers (NASBO).

But even with the growth, which comes on top of more modest improvements over the past couple of years, spending for states across the country remains below the 2008 peak when adjusted for inflation. In addition, 19 states still have general fund expenditures that are below pre-recession peaks, a fact that the report said speaks to the “uneven” nature of the economic recovery.

“To me, that is really, really telling that so many years into a recovery that so many states are still below pre-recession spending levels,” said Scott Pattison, executive director of NASBO.

Pattison noted that the recent improvements in state revenue has lagged behind historical growth averages. Worse, he said, the current improvement could mark a momentary peak.

States will no longer benefit from a spike in estate tax and capital gains revenue that came at the end of 2012 when many people cashed in profits as the possibility of higher federal tax rates loomed in 2013.

In addition, while states are budgeting for modest increases in Medicaid spending next year, those expenditures are poised to increase in future years, he said. Health-care costs are rising at a slower rate than in the past, but it is unclear how long that will last.