Abstract
Abstract The Great Recession had the most severe impact on state tax revenues of any downturn since the Great Depression. We hypothesize that states with more progressive tax structures are more vulnerable to economic downturns, and that progressivity and income volatility may interact to amplify the recession’s fiscal impact. We find that, while potential revenue exposure is greater in more progressive states, the most important source of variation was differences in income concentration and capital gains shares in the top 5 percent of taxpayers. Though the interaction between income volatility and high tax burdens at the top did produce large decreases in tax revenue in a few states, tax progressivity accounted for little of the overall interstate variation in revenue volatility. JEL codes H24; H71
Highlights
Stability of revenues is an important feature of sub-national revenue systems
This suggests that variation in the economic shock at the top of the income distribution is the key factor in explaining differences in the revenue exposure of states to the Great Recession
Income inequality, and economic shocks we present a set of regression models to explain the economic shock for the top 5 and 15 percent of the adjusted gross income (AGI) distribution as a function of income concentration and capital gains receipt
Summary
Stability of revenues is an important feature of sub-national revenue systems. Because spending obligations generally increase in recessions, and states and localities are sharply constrained in their ability to run deficits, the greater the volatility of revenues over the business cycle, the greater the pressure to cut spending and raise taxes during recessions, and the greater the incentive to expand spending commitments and cut taxes during recovery. We use the Great Recession as a test case to address the effect on state tax revenues of income concentration, capital gains receipt, and tax progressivity. Our principal finding is that, while potential revenue exposure is greater in more progressive states, the most important source of interstate variation in revenue exposure in the Great Recession was not state tax structure, but differences in the importance of income concentration and capital gains income, as well as the state-specific severity of the recession. These series are used to estimate national average responses of state sales and income tax revenues to the business cycle Their income measure excludes capital gains, and does not take account of variation across states in the cyclicality of tax bases. The change in revenue may be rewritten as ΔTax Revenuej 1⁄4 ð3Þ þ ð4Þ 1⁄4 Revenue Exposurej þ Revenue Offsetj; policy ð5Þ
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