Figure 1. Enacted Changes in State Taxes by Year of ...

NCSL FISCAL BRIEF: HOW STATE TAX
POLICY RESPONDS TO ECONOMIC
RECESSIONS

January 5, 2011

INTRODUCTION AND ACKNOWLEDGMENTS

This report examines state tax policy in response to national recessions and recoveries from 1988 to

the present. It tracks changes in three major

state taxes, the personal income tax (PIT), the

general sales tax (GST) and the corporate This report includes:
income tax (CIT) as the United States has
cycled through recession and recovery. This • A general introduction of how state tax
introduction explains state budget and tax policy responds to economic recessions.

practices that provide the background for the • Why year-end balances fall before the

discussion that follows. Three subsequent beginning and after the end of a recession.

sections examine state practices regarding the • Personal income tax policy changes and
PIT, GST and CIT in the course of the business recessions.
cycle. An appendix addresses methodological
issues. • General sales tax policy changes and
recessions.

Corina Eckl, NCSL Fiscal Program Group • Corporate income tax policy changes and
Director, originally suggested the research that recessions.
led to this paper. She read and improved a
number of drafts. Todd Haggerty, Fiscal Policy • A discussion of methodology.

Associate, devoted time and creativity to

designing and repeatedly revising the charts and

graphs. Julie Lays, Program Principal in the Communications Division edited and substantially

improved this paper.

National Conference of State Legislatures

How State Tax Policy Responds to Economic Recessions 2

HOW DOES STATE TAX POLICY RESPOND TO RECESSIONS?

What is the state tax policy response to recessions? Figure 1 provides a quick answer to that question.
It shows the states’ net tax changes enacted in a calendar year as a percent of the previous year’s
collections (blue line) and state year-end balances over the same period (red line). The year-end
balance is the sum of state general fund and rainy day fund reserves expressed as a percent of state
general fund expenditures for the year. When state year-end balances fall significantly, tax increases
are likely to follow. When balances are increasing, states are more likely to reduce taxes.

Figure 1. Enacted Changes in State Taxes by Year of Enactment and
State Year-End Balances 1988 –2009

This report is based on data that state legislative fiscal officers have provided to the National
Conference of State Legislatures (NCSL) for more than 25 years. The data include annual reports on
general fund revenues and appropriations, actual spending, the revenue impact of changes in tax law
and state year-end balances. NCSL began asking for such data in 1982, and by 1987 had
permanently settled on the kinds of data and a format that allow comparisons from 1988 to the
present. This information in described in more detail in the appendix.

States generally limit spending for a coming fiscal year to the revenues expected that year, plus any
available resources saved from previous years.1 A balanced budget is a constitutional or statutory

1 See NCSL, State Balanced Budget Provisions (October, 2010),
http://www.ncsl.org/documents/fiscal/StateBalancedBudgetProvisions2010.pdf

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How State Tax Policy Responds to Economic Recessions 3

requirement in most states, reinforced by limits on states' ability to borrow money as well as the
widespread expectation, practically a public mandate, that budgets be balanced. The appendix
provides more information on limitations on state borrowing.

The need to balance budgets requires careful revenue forecasting and the maintenance of reserves.
Reserves can compensate when actual revenues fall short of forecasts. Forty-seven states have
authorized budget stabilization funds (rainy day funds) for that purpose. States have various means of
building these savings accounts in periods of prosperity and limit their use to periods of necessity.2
Coupled with any balances remaining in the state general fund at the end of a fiscal year, these make
up states' year-end balances.

NCSL regards year-end balances as the most useful single indicator of state fiscal conditions. Balances
in the general fund and rainy day fund grow when revenues exceed forecasts, which tends to happen
in times of economic growth. Recessions, on the other hand, put pressure on revenues, causing
general fund balances to fall, and states may tap their rainy day funds. Total year-end balances reflect
these changes. Over time, year-end balances have proved to be a leading indicator of national
recessions: They begin to fall before recessions begin. They are not, however, an indicator of future
recoveries, since they tend to recover long after a recession has ended.

The periods when states experience falling balances and enact tax increases tend to be longer than
national recessions. And while state balances, as noted above, have proved to be a leading indicator of
recessions, there is no way of knowing in advance how deep a recession may be. Balances also tend to
fall after the official end of a recession, for reasons discussed later.

State officials generally postpone tax increases until balances have begun to fall, although that was not
the case in the years leading up to the recession of 1990-1991. It is impossible to foresee when a
recession will begin, and it may even go unrecognized for some time after it has begun. In 2000,
forecasters expected only a slight downturn in state revenues in the next year, not the recession that
started in March 2001.3 Nor were there obvious signs in the first months of 2008 of severe fiscal
deterioration, although a recession had begun in December 2007.4 The turning points in state year-
end balances that are so obvious in retrospect (see Figure 1) are undetectable when they occur.

Significant tax increases tend to occur while balances are falling, or after they have fallen, as
experience over the last three recessions shows.

• The recession of July 1990 to March 1991. State balances peaked at the end of FY 1989 (June
30, 1989, for 46 states) at the end of legislative sessions in which lawmakers collectively had

2 Arkansas, Kansas and Montana do not have budget reserve funds. See NCSL, “State Budget Stabilization
Funds,” September 2008, http://www.ncsl.org/default.aspx?tabid=12630

3 NCSL, State Budget Actions 2000 (Denver, 2001), 4; State Budget Actions 2001 (Denver, 2002), 4.
4 National Bureau of Economic Research (NBER), “Recession Over in June, 2009,” (September 20, 2010),
accessed at http://blogs.wsj.com/economics/2010/09/20/nber-recession-ended-in-june-2009/
NCSL. State Budget Actions FY 2008 and FY 2009 (Denver, 2009), 8-15

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How State Tax Policy Responds to Economic Recessions 4

increased taxes about 0.6 percent.5 As the country entered the recession in 1990, balances
continued to fall and legislators responded with tax increases averaging 3.4 percent. In 1991,
state fiscal conditions continued to deteriorate, and state official enacted the largest collective
state tax increase on record, 5.4 percent, effective in FY 1992. State balances continued to
fall well after the end of the recession, and hit their lowest point on record in June 1992 at
0.7 percent. States had no further appetite for tax increases in 1992, after which state
finances began a recovery that lasted into 2000.

• The recession of March to November 2001. State balances hit what was then a record high of
10.4 percent at the end of FY 2000. The downturn that began in March 2001 was sharp but
short. Year end balances fell to 4 percent at the end of FY 2002. By the time the recession
began, policymakers had cut taxes for six years in a row. They continued with very modest
cuts in 2001. State fiscal difficulties lingered after the recession ended, causing state balances
to fall further in FY 2003. In their 2002 and 2003 sessions, legislators enacted tax increases
that were modest in comparison to those of the early 1990s: 1.6 percent of previous-year
collections each year. Recovery benefited state budgets in the following years, and year-end
balances hit a new record high of 12.3 percent by the end of FY 2006.

• The recession of December 2007 to June 2009. The latest recession lasted longer than its two
predecessors combined, and longer than any 20th century recession except the one from
1929 to 1933. State balances fell slightly from their FY 2006 high by the end of FY 2007,
but remained at almost 11 percent. Legislatures enacted relatively small tax increases in 2007
and 2008: 0.6 percent and 0.5 percent of collections, respectively. By the time legislatures
convened in 2009, the devastating impact of the recession on tax collections was clear.
Balances at the end of FY 2009 were lower than they had been since 2004, and state officials
responded by enacting the largest tax increases since 1991.

Although state tax increases accompany recessions, legislators try to delay them as long as possible for
several good reasons. First is the damaging effect tax increases can have on consumers and businesses
already experiencing falling incomes. Second, raising taxes can make it appear that policymakers are
disregarding their constituents’ economic distress. Third, policymakers are hesitant to act in a way
that could turn out to be premature. If they increase taxes in a downturn that proves to be short and
shallow, pre-emptive action could be interpreted as an over-reaction. Therefore, policymakers prefer
to respond to falling revenues by reducing or postponing expenditures, using reserves and finding
other substitutes for tax increases.

Lawmakers have many potential sources of revenue to respond to recessions. Major shortfalls,
however, are likely to lead policymakers to increase the personal income, general sales or corporate
income taxes because of their broad bases and revenue productivity. In 2009, these three together

5 In this report, measures of tax increases are stated as a percentage of the previous year's tax collections.
National Conference of State Legislatures

How State Tax Policy Responds to Economic Recessions 5

produced 72 percent of state tax collections.6 When policymakers need to collect substantially more
tax revenue, these are the logical revenue sources to tap.

Figure 2 shows the annual amount of enacted changes in each of these three major taxes from 1988
to 2010. The numbers shown here are projections of tax changes at the time they were enacted, not
actual collections.7

Figure 2 demonstrates how state tax increases follow recessions, as state fiscal conditions reach a low
point after accumulated reserves and temporary expedients are exhausted. It also suggests that
policymakers make somewhat different use of the tax possibilities open to them. Table 3, which
shows the annual data depicted in Figure 2, helps to explain that point.

Figure 2. Projected Revenue Effect of Tax Law Changes By Type

Figure 2 shows how hikes in the three major state taxes occur most often during and immediately
following recessions, while tax cuts occur during periods of recovery. A longer-term pattern of change
in state tax policy is not visible in Figure 2, but emerges from Table 3. It shows the annual net change
in personal income, general sales, and corporate income taxes from FY 1988 through FY 2010. Net

6 Bureau of the Census, State Government Tax Collections, 1992, 2008; NCSL, “State Reliance on Major Tax
Sources (2009) accessed at http://www.ncsl.org/default.aspx?tabid=21375
7 This chart indicates the amount of tax changes in the fiscal year they took effect. It differs from figure 1,
which shows the amount of tax changes in the year of enactment, which is why the peaks and valleys of tax
changes move to the right compared to the tax line in figure 1. Tax changes generally are effective in the year
following enactment, but major tax changes are sometimes put into effect over two or more fiscal years.

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How State Tax Policy Responds to Economic Recessions 6

change is the sum of all increases and decreases. Over the 23-year period of the study, Table 3 reveals
a net reduction in the personal income tax and net increases in the general sales tax and corporate
income tax (without taking inflation into account).

These conclusions also can be drawn from figure 2 and table 3:

• Increases in the personal income tax spike more decisively in response to recessions than
increases in the sales tax, which tend to be spread out over more years.

• Income tax reductions in during recoveries more than offset increases enacted in or near
periods of recessions.

• Sales tax reductions in the course of recoveries did not match increases during recessions.

• Decreases in corporate income taxes over the 23-year period did not offset increases.

Table 3. Projected Revenue Effect of Tax Law Changes, By Type in

Millions of Dollars

FISCAL YEAR PERSONAL GENERAL SALES CORPORATE
INCOME TAX
INCOME TAX TAX

1988 $365.0 $2,065.5 $77.4

1989 -77.5 1,022.7 179.5

1990 -614.4 1,255.2 574.5

1991 2,535.7 2,747.7 776.1

1992 8,806.2 5,500.9 2,276.6

1993 372.9 1,390.4 245.8

1994 1,007.6 1,912.4 190.5

1995 -97.7 1,524.8 -262.1

1996 -2,001.6 -102.7 -1,068.2

1997 -2,475.6 -148.8 -578.2

1998 -1,421.2 -670.0 -408.9

1999 -3,914.4 -172.3 -608.3

2000 -3,457.9 -3187.7 -1,275.9

2001 -4,234.7 -2207.8 -701.5

2002 -2,821.5 115.3 -691.3

2003 574.4 1,668.9 2,217.4

2004 2,751.3 3,749.1 767.0

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How State Tax Policy Responds to Economic Recessions 7

Table 3. Projected Revenue Effect of Tax Law Changes, By Type in

Millions of Dollars

FISCAL YEAR PERSONAL GENERAL SALES CORPORATE
INCOME TAX
INCOME TAX TAX

2005 1,215.7 1,234.7 557.2

2006 -565.5 468.5 116.3

2007 -2,466.8 869.4 -521.0

2008 -2,550.6 510.9 2,887.7

2009 -2,142.0 1,148.1 2,146.6

2010 10,858.3 7,161.5 1,659.2

NET CHANGE -212.2 27,856.7 8,556.4

Why do year-end balances fall before the beginning and after the end of a recession?

State year-end balances begin to deteriorate before recessions begin, and continue to do so after they end
because they reflect what's happening with state finances. Balances are sensitive to the economy because state
tax collections are. About 70 percent of state tax collections are from taxes that respond quickly to the
economic cycle–the general sales tax, personal income tax and corporate income tax. Changes in consumer
and business spending affect collections within a month or two. Personal income tax withholding on wages
and salaries is also a sensitive indicator. The other portions of the personal income tax base and the corporate
income tax respond more slowly to changing economic conditions. Every April, when the previous year's tax
obligations are resolved, the final numbers indicate where the economy has been trending.

Economic deterioration does not necessarily lead to a recession. According to the National Bureau of
Economic Research, the body that officially defines recessions in the United States, “a recession is a
significant decline in economic activity spread across the economy, lasting more than a few months,
normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

Since NCSL began collecting data in 1988, each significant decline in year-end balances has preceded a
recession. Whether or not that is necessarily the case will be unknown until an exception is recorded. For
now, it's possible to say only that the responsiveness of state tax collections to the business cycle means that
year-end balances will deteriorate before a recession begins.

The same responsiveness to economic conditions can prolong deterioration in state year-end balances after a
recession ends. Recovery can occur along with an increase in unemployment that in turn causes slow growth
in personal income, consumption and corporate profits, and thus slow growth in state tax collections. After
the recession of 1990-1991, the national unemployment rate stayed above the 1990 level of 5.6 percent until
1995. After the 2001 recession, employment did not return to the level of 2000 until 2006. The end of the
2007-2009 recession similarly has similarly been followed, to date, by a jobless recovery, accompanied by a
slow recovery in state fiscal strength.

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How State Tax Policy Responds to Economic Recessions 8

PERSONAL INCOME TAX POLICY CHANGES AND RECESSIONS

The state personal income tax plays two important roles in state finance. It is the single largest source
of tax collections for state governments. It produced more than 34 percent of state tax collections in
2009, and has in the past provided a higher percentage. It is second only to federal aid as a source of
state revenue. Second, the tax’s broad base and flexibility of design make it an important source of
increased revenue when states face fiscal crises.

Figure 4 shows periods of national recession as gray bars. The red line indicates annual state year-end
balances as a percent of state general fund expenditures. When balances peak as they did in 1989,
2000 and 2006, state fiscal conditions are strong. When they sink after those peaks, state fiscal
conditions are deteriorating. As figure 4 indicates, state balances tend to reach their cyclical lows after
a recession has ended, since the end of a recession marks only the beginning of recovery, not
restoration of state revenue collections. The blue line shows the annual net effect of personal income
tax changes in each fiscal year, in millions of dollars. The graph shows that when balances and general
fiscal conditions are deteriorating seriously, state policymakers were are more likely to increase
personal income taxes than at any other time.

Figure 4. Annual Net Changes in State Personal Income Taxes,
State Year-End Balances, and Periods of Recession

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How State Tax Policy Responds to Economic Recessions 9

Figure 4 demonstrates the inverse relationship between net changes in state personal income taxes
and state year-end balances. For FY 1992, when state balances dropped to a record low following the
recession of 1990-91, income taxes were increased by the highest nominal amount until 2010, and by
a percentage that remains the record. In 1991, 23 of the 40 states with a broad-based income tax
raised taxes for a net increase of $8.8 billion, and Connecticut enacted a new personal income tax.
That was the greatest number of states increasing income taxes for a given year. California,
Connecticut and Pennsylvania each expected to produce more than $1 billion in additional revenue.
Decreases (enacted by 11 states) were the smallest of any year covered in this report.

The recovery in the economy and state balances in FY 1995 brought a return to net annual income
tax cuts that lasted through FY 2002, despite the recession in 2001. Year-end balances reached 10.4
percent of state general fund spending in FY 2000, which softened the impact of falling state
revenues for the next two fiscal years. As year-end balances fell toward a 10-year low of 3.5 percent in
FY 2003, legislators enacted net increases in the personal income tax effective in FY 2003, 2004 and
2005. By the time the last of the increases took effect, state fiscal conditions had become more
favorable. Net personal income tax changes decreased from FY 2006 through FY 2009, a trend
sharply reversed by increases effective for FY 2010.

Broad-based personal income taxes exist in 41 states and the District of Columbia. New Hampshire
and Tennessee tax only investment income, not wages and salaries. Income tax proponents value their
structure for productivity and for providing an element of progressivity in state tax systems, which are
otherwise heavy on regressive taxes. Opponents argue the tax is a drag on economic growth and
penalizes earnings, savings and investments (since investment returns are subject to the income tax).

The long-term trend has been for collections from the personal income tax to make up a larger share
of state tax collections. The recession of 2007-2009 ended the trend, but economic recovery will
probably cause it to resume. The shrinkage in the relative importance of the general sales and
corporate income taxes is partly because of changes distinctive to each, but also because collections on
capital gains assumed great importance in the economic booms of the late 1990s and the early 2000s.
Reliance on capital gains increased the volatility of income tax collections, and shifted its incidence
toward high-income taxpayers. To a limited extent, state policy since 1988 has mitigated these effects
by flattening the rate structures.

In 1988, the District of Columbia and 33 of the 41 states that had broad-based personal income
taxes used graduated rates. The other eight imposed a single–or flat–rate. Since then, Utah has
replaced its graduated income tax with a flat tax. Of the other 32 states that had graduated rates in
1988, 14 have reduced the top rate, as has the District of Columbia. In 1988, rates on top earners
ranged from 9 percent to 12 percent in nine states. Only three states, however, had marginal rates of
9 percent or higher in 2008, and the highest marginal rate was only 9.5 percent. Sixteen states

National Conference of State Legislatures

How State Tax Policy Responds to Economic Recessions 10

increased the starting income level for their highest bracket, which has had the effect of moving some
taxable income from the highest to the next-highest bracket.8

Most of the rate changes were 1 percentage point or less, but some were dramatic: Connecticut's top
rate went from 12 percent to 5 percent, Montana's from 11 percent to 6.9 percent and North
Dakota’s from 12 percent to 5.54 percent (as of 2008). The long-term trend before the recession that
began in 2007 was to flatten personal income tax rates (a trend states have reversed at least
temporarily since 2007). Without this trend, personal income taxes would have assumed even more
importance as a source of state tax collections.

States have enacted income tax cuts more frequently than increases, as shown in table 5. Over the
past 20 years, decreases in individual states have tended to be small but numerous; increases have
been less frequent but larger. Even in 2001 and 2008, when state fiscal conditions were visibly
deteriorating, income tax cuts outnumbered increases.

Table 5. Number of States That Made Changes
to the Personal Income Tax

CALENDAR

YEAR INCREASES DECREASES BOTH NET
13
1988 3 10 0 30
22
1989 14 17 1 28
21
1990 17 94 19
25
1991 24 11 7 22
20
1992 15 82 32
37
1993 12 81 32
30
1994 12 19 6 27
24
1995 4 19 1

1996 5 18 3

1997 4 30 2

1998 2 36 1

1999 5 30 3

2000 4 27 1

2001 10 26 9

2002 13 15 4

8 Information on personal income tax rates and brackets is from the Advisory Commission on
Intergovernmental Relations, Significant Features of Fiscal Federalism, 1989 Edition (Washington, D.C.: January
1989) I:34ff and Federation of Tax Administrators, “State Comparisons,” at
http://www.taxadmin.org/fta/rate/tax_stru.html.

National Conference of State Legislatures

How State Tax Policy Responds to Economic Recessions 11

Table 5. Number of States That Made Changes

to the Personal Income Tax

CALENDAR

YEAR INCREASES DECREASES BOTH NET
22
2003 17 83 16
32
2004 10 93 27
35
2005 14 26 8 26
27
2006 3 25 1

2007 15 30 10

2008 8 20 2

2009 17 18 8

Table 6 shows the estimated impact of state changes in the personal income tax for the fiscal years in
which the changes took effect. The table includes changes whose effective dates were delayed or
phased in. For any fiscal year, the amounts reflect when tax changes took effect, not when they
passed.

Since 1988, states have cut income taxes most years except for those immediately following recessions
(Table 6). The trend continued into the beginning of the 2007-2009 recession. Before sizeable
income tax increases were enacted for 2010, the average annual net effect from 1988 through 2009
was a reduction of about $500 million a year, in part a result of the flattening of rates described
previously. Economic growth fueled growth in collections most years, while policy changes slowed
the rate of growth. The 2009 enactments largely offset this trend; the increases that took effect in FY
2010 were larger in real terms than any since 1992, and were the largest dollar increases in income
tax levies on record.

Table 6. Estimated Revenue Impact of Personal Income Tax Changes
(in Millions of Dollars)

FISCAL YEAR TOTAL TOTAL NET
INCREASES DECREASES CHANGE

1988 1,335.0 -970.0 365.0

1989 208.0 -285.5 -77.5

1990 1,474.0 -2,088.4 -614.4

1991 2,727.6 -191.9 2,535.7

1992 8,989.9 -183.7 8,806.2

1993 1,160.4 -787.5 372.9

1994 1,325.3 -317.7 1,007.6

1995 1,124.8 -1,222.5 -97.7

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How State Tax Policy Responds to Economic Recessions 12

Table 6. Estimated Revenue Impact of Personal Income Tax Changes

(in Millions of Dollars)

FISCAL YEAR TOTAL TOTAL NET
INCREASES DECREASES CHANGE

1996 21.0 -2,022.6 -2,001.6

1997 574.3 -3,049.9 -2,475.6

1998 64.1 -1,485.3 -1,421.2

1999 139.6 -4,054.0 -3,914.4

2000 305.1 -3,763.0 -3,457.9

2001 99.7 -4,334.4 -4,234.7

2002 237.2 -3058.7 -2,821.5

2003 1,560.5 -986.1 574.4

2004 3,140.5 -389.2 2,751.3

2005 2,155.7 0.0 1,215.7

2006 905.8 -1,471.3 -565.5

2007 295.1 -2761.9 -2,466.8

2008 1,071.5 -3,622.1 -2,550.6

2009 397.3 -2,539.3 -2,142.0

2010 11,989.5 1,131.2 10,858.3

TOTALS 41,301.9 -41,514.1 -212.2

Figure 7 graphically displays the information in Table 6. For each fiscal year, the length of the blue
bar indicates the personal income tax increases effective in a fiscal year, and the red bar measures
decreases. The solid line represents the amount of net increase or decrease.

National Conference of State Legislatures

How State Tax Policy Responds to Economic Recessions 13

Figure 7. Estimated Revenue Impact of Personal Income Tax Changes

As Figure 7 demonstrates, changes in the personal income tax are reflections of state fiscal conditions.
Reductions are enacted when state balances are strong, or at least growing. Sharp declines in state
balances make increases more likely, though not certain. If past experience can predict future actions,
states are likely to reduce personal income taxes when their fiscal conditions recover.

GENERAL SALES TAX POLICY CHANGES AND RECESSIONS

The state general sales tax is the second largest source of state tax collections. In 2008, it produced
almost 32 percent of state tax revenue, a slightly smaller share than the personal income tax. Its base
consists of the retail sale of goods and services, as defined by each state that levies the tax. The
breadth of the base means that any change in the rate can have a substantial revenue impact.

Because rate changes can be applied quickly after enactment, states have often increased sales taxes in
response to revenue shortfalls. The tax's sensitivity to the economic cycle reduces its usefulness,
however. Recessions induce a fall in discretionary consumption, so sales tax productivity shrinks with
a recession. The sales tax is also regressive: Taxpayers with lower incomes pay a larger percentage of
their income in sales tax than do taxpayers with higher incomes. Considerations of vertical equity
may limit increases in the sales tax when personal income is stagnant or falling.

Figure 8 shows the annual net effect of changes enacted in the general sales tax from FY 1988
through FY 2010, comparing the changes to state year-end balances and marking periods of national

National Conference of State Legislatures

How State Tax Policy Responds to Economic Recessions 14

recession as gray bars. Net tax changes are shown by the blue line and year-end balances as a percent
of state general fund expenditures by the red line.

Figure 8. Annual Net Change in State General Sales Tax,
State Year-End Balances, and Periods of Recession

As Figure 2 on page 5 shows, sales tax increases and decreases have followed a pattern similar to that
for personal income taxes over the past 23 years. When balances peak as they did in 1989, 2000 and
2006, and state fiscal conditions are strong. states moderate their increases or reduce sales taxes.
When balances are weak, states are likely to increase sales taxes. As a general rule, though, changes in
sales taxes are less dramatic than those in personal income taxes.
The amounts of annual sales tax changes appear in Table 9. Figure 10 shows amounts of annual
increases and decreases as well as year-by-year net change. Net changes over the 23-year period
reflected in Tables 6 and 9 include 14 instances of net reductions in the personal income tax and only
five for the general sales tax. Overall sales taxes have increased in periods of economic expansion as
well as after recessions. The largest increases, however, have been in the wake of national recessions,
as has been the case with personal income taxes.

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How State Tax Policy Responds to Economic Recessions 15

Table 9. Estimated Revenue Impact of State General Sales Tax Changes

(in Millions of Dollars)

FISCAL YEAR TOTAL TOTAL NET CHANGE
INCREASES DECREASES

1988 2,076.5 -11.0 2,065.5

1989 1,108.7 -86.0 1,022.7

1990 1,329.9 -74.7 1,255.2

1991 2,816.4 -68.7 2,747.7

1992 6,115.7 -614.8 5,500.9

1993 2,371.8 -981.4 1,390.4

1994 2,291.5 -379.1 1,912.4

1995 1,720.1 -195.3 1,524.8

1996 96.2 -198.9 -102.7

1997 500.8 -649.6 -148.8

1998 160.3 -699.9 860.2

1999 344.8 -517.1 -172.3

2000 110.4 -3,298.1 -3,187.7

2001 169.4 -2,377.2 -2,207.8

2002 1,523.6 -1,408.3 115.3

2003 2,073.7 -404.8 1,668.9

2004 4254.0 -504.9 3749.1

2005 1,675.4 -440.7 1,234.7

2006 1,449.2 -980.7 468.5

2007 1,838.9 -969.5 869.4

2008 1,252.5 -741.6 510.9

2009 1,432.6 -284.5 1,148.1

2010 7,429.8 -268.3 7,161.5

Totals 44,142.2 -16,285.5 27,856.7

Averages 1,919.2 -708.1 1,211.2

National Conference of State Legislatures

How State Tax Policy Responds to Economic Recessions 16

Figure 10. Estimated Revenue Impact of General Sales Tax Changes

States have enacted the largest increases in sales taxes in the years following recession. In Table 9, FYs
1992, 2004 and 2010 show the greatest net increases. In that regard, changes to the sales tax have
been similar to changes to the income tax. States have been less likely, however, to reverse large
increases in sales taxes during a recovery than in the income tax. After the recession of 1990-1991,
sales tax increases continued until FY 1995, and net sales tax increases have continued without
interruption since FY 2002.

Table 11. Number of States That Have Enacted Increases and Decreases
in the General Sales Tax

CALENDAR INCREASES DECREASES BOTH NET
YEAR

1988 12 6 2 16

1989 15 5 2 18

1990 21 7 4 24

1991 18 10 2 26

1992 12 9 2 19

1993 13 8 2 19

1994 7 17 3 21

1995 6 14 2 18

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How State Tax Policy Responds to Economic Recessions 17

Table 11. Number of States That Have Enacted Increases and Decreases
in the General Sales Tax

CALENDAR INCREASES DECREASES BOTH NET
YEAR

1996 3 19 2 20

1997 6 20 3 23

1998 2 21 1 22

1999 4 27 1 30

2000 6 25 3 28

2001 8 20 2 26

2002 12 11 5 18

2003 20 14 7 27

2004 9 19 5 23

2005 11 22 5 28

2006 6 26 0 32

2007 7 26 2 31

2008 5 19 1 23

2009 18 9 2 25

States frequently revise sales taxes. At least half the 45 states with this tax make annual changes, as
Table 11 indicates. Most of the changes affect specific items in the tax base and have a relatively small
effect on revenues. For example, in 2006, 32 states revised their sales tax laws. In six states the
changes increased collections, while in 26 they reduced them. As Table 9, shows, the increases
amounted to almost $1.5 billion and the decreases to almost $1 billion.

A small number of rate changes in 2006 were responsible for much of the collective net revenue
change. About $1.1 billion of the increases resulted from higher rates enacted in Ohio and North
Carolina. Idaho and Virginia were responsible for around $300 million of the reduction through rate
cuts. The remaining 80 changes were relatively minor reductions or expansions of tax bases. These
included a sales tax holiday for clothing, books and school supplies in Florida (reducing revenues by
$38 million), phasing out the residential utility sales tax in Iowa ($18 million), and exempting self-
service laundries in Washington ($1 million). On the other side of the ledger, New York extended
the sales tax base to direct interstate wine shipments (generating $2 million), and North Carolina
began taxing candy ($10 million).

When changes were enacted in 2009 and made effective in FY 2010, almost all states suffered from
weak revenue collections. Yet 96 percent of the net increase of $7.1 billion occurred in only four
states: California, Massachusetts, New York and North Carolina.

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How State Tax Policy Responds to Economic Recessions 18

The pattern was the same in FY 1992, the year with the next highest sales tax increases on record. Of
the net increase of $5.5 billion, $3.8 billion was attributable to California, and another $720 million
to Ohio and Pennsylvania. Of the $614 million states cut from their sales taxes that year, $550 was
the work of Massachusetts and Connecticut. Increases in FY 2004 did not reach the FY 1992 record,
but the net change was an increase of $3.7 billion, of which $2.7 billion was due to changes in New
York, Ohio and North Carolina.

Net reductions in sales taxes tend to be spread out more evenly over time than increases, but show a
similar pattern of large changes concentrated in a few states, and small changes spread out over many.
The largest net reduction occurred in 2000, when increases totaled only $110 million and reductions
were almost $3.3 billion. Sales tax rebates, rather than rate cuts, in Colorado, Minnesota and
Wisconsin accounted for more than $2.5 billion of the $3.2 billion in reduced collections.

CORPORATE INCOME TAX POLICY AND RECESSIONS

State corporate income taxes have traditionally been regarded as the third major source of state tax

revenue, along with the personal income tax and the general sales tax, but they come in a distant

third. In 2009, the corporate income tax produced 5.6 percent of total state tax collections—less than

one-fifth of the revenue from either the personal income tax or the general sales tax. As Figure 12

shows, the tax has Figure 12. Percent of State Tax Collections Attributable to the Corporate
generally declined as a Income Tax, FY 1970 to FY 2009

share of state tax

collections since 1980,

when it produced 9.7

percent. It is also highly

responsive to the

business cycle and in the

wake of the recession of

2001, it sank to 4.7

percent of state tax

collections.

After reaching 9.7
percent in 1979 and
1980, the next high
point of corporate
income productivity
occurred in 1987, at 8.4
percent of state tax
collections. Its revenues fell sharply during the recessions of 1990-1991 and 2001. A sharp recovery
from 2005 to 2007 has since been reversed. Its erosion as a source of state revenue is variously
interpreted as a by-product of changes in the federal corporate income tax (since most states are

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How State Tax Policy Responds to Economic Recessions 19

coupled to the federal base), to state failure to adapt the tax to changing economic circumstances, to
interstate competition for business, and to more sophisticated tax planning on the part of taxpayers.

Since some of the falling productivity of the corporate income tax is attributable to state policy
decisions, in theory states could reverse those policies to increase their reliance on the tax. To some
extent states have done so when fiscal conditions were weak. Figure 13 shows the relationship of
changes in the corporate income tax to state fiscal conditions, as measured by state year-end balances.

Figure 13. Annual Net Effect of Changes in the State Corporate Income Tax,
State Year-End Balances, and Recessions

Figure 13 shows periods of national recession as gray bars. The red line indicates annual state year-
end balances as a percent of state general fund expenditures. When balances peak as they did in 1989,
2000 and 2006, state fiscal conditions are strong. When they sink after those peaks, state fiscal
conditions are deteriorating. As Figure 13 shows, state balances tend to reach their cyclical lows after
a recession has ended. The end of a recession marks only the beginning of recovery and not the
restoration of former levels of revenue.

As Figure 13 indicates, falling year-end balances make increases in the corporate income tax more
likely. As state fiscal conditions improve in the wake of recessions (as measured by year-end balances),
states have tended to make net cuts in the tax. They did so annually from FY 1995 through FY 2002,
and then returned to net increases in the years after the recession of 2001. The years since FY 2002
have brought increases, with the exception of FY 2007. Immediately after the recession of FY 2001,
these appear to have been driven by the need for state revenues. From FY 2005 through FY 2008, the

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How State Tax Policy Responds to Economic Recessions 20

increases were a result of restructuring state taxes rather than a need to balance state budgets, as
discussed below. In 2009, states returned to recession-driven increases, although California and Ohio
also made significant corporate income tax cuts effective in FY 2010. In California, the goal was
economy recovery. Ohio continued a multi-year shift in the structure of business taxes that resulted
in a net cut in business tax collections because of the recession.

Table 14 shows the estimated revenue impact of the states’ changes in the corporate income tax in the
first year the changes took effect. It lists the total increases effective in each fiscal year, the total
decreases, and the net change.

Table 14. Estimated Revenue Impact of State Corporate Income Tax

Changes

FISCAL YEAR TOTAL TOTAL NET CHANGE
INCREASES DECREASES

1988 $ 171.4 $ -94.0 $ 77.4

1989 195.0 -15.5 179.5

1990 581.4 -6.9 574.5

1991 798.8 -22.7 776.1

1992 2,370.4 -93.8 2,276.6

1993 341.9 -96.1 245.8

1994 772.4 -581.9 190.5

1995 194.3 -456.4 -262.1

1996 42.4 -1,110.6 -1,068.2

1997 38.5 -616.7 -578.2

1998 31.2 -440.1 -408.9

1999 122.3 -730.6 -608.3

2000 172.1 -1,448 -1,275.9

2001 536.7 -1,238.2 -701.5

2002 557.8 -1,249.1 -691.3

2003 2543.5 -326.1 2217.4

2004 1,220.1 -453.1 767.0

2005 898 -340.8 557.2

2006 766.3 -650.0 116.3

2007 659.5 -1,180.5 -521.0

2008 5,669.7 -2782.0 2,887.7

2009 3,638.1 -1,491.5 2,146.6

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How State Tax Policy Responds to Economic Recessions 21

Table 14. Estimated Revenue Impact of State Corporate Income Tax

Changes

FISCAL YEAR TOTAL TOTAL NET CHANGE
INCREASES DECREASES

2010 3,074.5 -1,415.3 1,659.2

Totals 22,321.8 -15,24.6 6,897.2

Averages 1,104.2 -732.2 372.0

Some significant conclusions about state changes in the corporate income tax can be made from
Table 14. One is that, on average, corporate income tax increases have been greater than decreases
between 1988 and 2010. Another is that the increases have been concentrated in a few years, as the
line for net change in Figure 13 also shows.

As noted earlier, state collections from the corporate income tax have fallen over time as a share of
total state tax collections, despite a recovery after 2005 . Figure 12 demonstrates that until the
upswing in collections from 2005 to 2007, the previous economic recoveries did not carry corporate
income tax collections back to their previous high points as a share of total state tax collections.

State net changes in the tax appear to have moderated the decline for the states as a group, since
average annual increases over the period were $372 million greater than decreases. This conclusion
applies to national averages, but for most states it is misleading, since the average is largely
attributable to very large increases in a few states due to fiscal stress, and to tax shifts when Michigan,
Ohio and Texas made significant changes between 2006 and 2008.

States enacted net increases of more than $2 billion effective in fiscal years 1992, 2003, 2008 and
2009. The changes for 1992 and 2003 can be attributed to recessionary fiscal stress. In those two
years, decisions in a few states accounted for most of the increase. Of the $2.4 billion in increases
effective for FY 1992, 79 percent was the result of decisions in California, Pennsylvania and Texas.
Of the $2.5 billion increases effective for FY 2003, 80 percent was attributable to California and New
Jersey.

The increases shown for FY 2008 were principally the result of tax swaps in Michigan, Ohio and
Texas, not a crisis-driven search for additional revenue. In its 2006 and 2007 legislative sessions,
Michigan replaced its Single Business Tax, a variety of the value-added tax, with a different business
tax structure. Ohio in the same years moved from its old corporate income tax (called a franchise tax
but based on corporate income) to its new Commercial Activity Tax, a gross-receipts tax. These
exchanges were more or less revenue neutral. That is indicated in Table 14 by the larger-than-usual
reductions in taxes reported for FYs 2007, 2008 and 2009. However, $3.4 billion of the increase
reported for FY 2008 represents an expansion of the Texas franchise tax to provide additional state
funding to replace local school district taxes, another kind of tax swap.

Changes in FYs 2009 and 2010 were largely driven by a need for additional revenue. However, some
of the change in both years is attributable to the continued phase-in of the shifts in tax policy in

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How State Tax Policy Responds to Economic Recessions 22

Ohio, which largely balanced increased collections from one tax with decreased collections from
another. In FY 2009, increases in California and Massachusetts accounted for 90 percent of the net
change in all states. Similarly, for FY 2010, the three states with the largest net increases—New York,
Pennsylvania and Nevada—accounted for more than 90 percent of the net increase for all states.

Table 15 shows the number of states that have revised their corporate income taxes annually since
1988. It shows the number that made increases and decreases, how many enacted both, and the net
number of states that enacted revisions.

Table 15. Number of States That Made Changes to the Corporate
Income Tax

CALENDAR INCREASES DECREASES BOTH NET
YEAR

1988 5 3 08

1989 9 5 0 14

1990 17 3 3 17

1991 23 9 1 31

1992 8 5 1 12

1993 18 12 4 26

1994 5 19 2 22

1995 8 11 3 16

1996 4 15 3 16

1997 7 21 2 26

1998 8 30 5 33

1999 12 23 4 21

2000 9 17 3 23

2001 7 20 2 25

2002 11 15 2 24

2003 15 10 1 24

2004 13 18 5 26

2005 16 27 7 36

2006 4 26 0 30

2007 10 27 4 33

2008 13 18 3 28

2009 19 19 9 29

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How State Tax Policy Responds to Economic Recessions 23

APPENDIX: NOTES, SOURCES AND METHODOLOGY

1. Period studied. This report begins with data for fiscal year (FY) 1988 because in 1987 NCSL fiscal
staff began collecting tax law changes and their revenue impact in the format and level of detail that
are used at present.

2. Nature of the data. This report is based on data that state legislative fiscal officers have provided to
NCSL for more than 25 years. The data include annual reports on general fund revenues and
appropriations, actual spending, the estimated impact of changes in tax law, and state year-end
balances. NCSL began asking for such data in 1982, and by 1987 had permanently settled on the
kinds of data and a format that allow comparisons for the period from FY 1988 to the present.

The data are collected annually after legislatures have completed their budget and tax enactments for
the coming fiscal year. The data are intended as a snapshot of legislative actions that affect the
coming fiscal year or biennium. The revenue estimates connected with each tax action are
prospective, reflecting a legislature's best estimate of the revenue effect of its actions. Thus, the
numbers used in this report are forecasts of the effect of tax law, not the actual results of changes in
tax law. Data used for this report are those published in State Tax Actions, State Budget Actions or
State Budget and Tax Actions, beginning with the 1987 report State Budget Actions.

The tax data NCSL collects show the projected revenue impact of changes in the fiscal year in which
they take effect, and the full fiscal year impact the changes are expected to have. Those are not always
the same, since tax changes often are in effect for only part of a fiscal year after they have been
enacted. Some increases and reductions are phased in over two or more years. This report includes
studies of the personal income, general sales, and corporate income taxes. The detail in the data have
made it possible to calculate the increases, decreases and net change for each of those taxes for each
fiscal year from FY 1988 through FY 2010, regardless of the date of the change that affected any
given fiscal year. Thus the numbers used in this report can differ in detail from those reported in
NCSL’s annual State Tax Actions, because its focus is the impact that the enactments in a year have
on the following fiscal year.

NCSL also collects data on state general funds. States divide their revenue collections into funds, of
which the general fund is the largest in almost every case. With some exceptions, states deposit most
tax collections in the general fund. States receive additional revenues outside the general fund, such as
receipts from the federal government and revenues that are legally set aside, or "earmarked" for
specific expenditures. An example of the latter is motor fuel excise taxes legally designated for
transportation spending. As a rule, general funds make up about half of all state revenues and
expenditures and are the focus of the state appropriations process. NCSL collects annual data on
general fund revenues and appropriations for newly enacted budgets as well as the actual general
revenues collected and expenditures from the general fund for completed fiscal years.

3. Limits on borrowing. Restrictions on states’ ability to borrow enforce constitutional and statutory
requirements for balanced budgets. Short-term borrowing for cash-flow purposes within a fiscal year
or a biennium is not unusual. Long-term borrowing—for more than 12 months—is restricted by

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How State Tax Policy Responds to Economic Recessions 24

statutes or constitutions in most states. In some states, long-term borrowing requires a popular vote
and in all the rest it requires a specific legislative act. These circumstances would impose practical
limits on states' ability to run annual deficits even if there were no legal requirements for balanced
budgets. Although some legislatures have the power to issue long-term debt, most states avoid doing
so to finance continuing operations. State tactics like postponing contributions to pension trust fund
or rolling one fiscal year’s obligations into the next fiscal year are a form of borrowing—in the sense
of postponing payment into the future—and states sometimes replace capital appropriations from
annual funds with debt. On the whole, though, state governments have to live within their annual
resources.

4. Some measurement issues. This report focuses on measuring the revenue impact of decisions on
taxes made in legislatures for a given fiscal year. That focus leads to the following rules on treating
some events that could be presented in more than one way.

• In the case of tax changes that are phased in gradually over a number of years, this report
shows the incremental effect of the change in each ensuing fiscal year for which there is a
specified additional impact.

• This report generally follows the taxpayer liability method of measuring tax changes. This
method counts the renewal or continuation of a tax that previously was scheduled to expire
as a tax increase. The rationale for this method is that the legislature made a positive decision
to increase revenues above the amount they would have been without the action.

• The ending of a temporary tax as scheduled does not count as an enacted tax reduction.
Examples are the termination of temporary income tax increases as scheduled at the end of
tax year 1991 in Massachusetts and Pennsylvania (STA 1992, pp 34-35). The temporary
postponement of one step in the multi-year phasing in or repeal of a tax is counted, when
appropriate, as a tax cut or a tax hike, since the taxpayer's liability was altered from what it
would have been before the change.

National Conference of State Legislatures