Stae Budgets: Repeating Past Mistakes (Stephan Moore)

Stephen Moore: Christmas Comes Early for State Budgets
             Flush with a one-time tax inflow, the spenders in both parties are repeating the mistakes of the past decade.


A new fiscal year began on Monday in most states. To celebrate, capitals from Hartford to Sacramento are going on a spending spree, acting as if the recent fiscal crisis never happened.

Because states must balance their budgets, the recession that began in December 2007 led to a revenue drought and several years of virtually flat and even declining budgets. But happy days are here again for both parties, thanks to an unexpected bump in revenues this year.

Exhibit A is California's Democratic Gov. Jerry Brown, who just signed a $96.3 billion budget, up from $87 billion two years ago, amid a festival atmosphere in Sacramento. This was the first real increase since the Golden State's $60 billion deficit three years ago.

Oil-rich North Dakota is also celebrating Christmas early. The Republican legislature and Gov. Jack Dalrymple approved budgets this spring for the next two years that pump up spending by more than 50%. The budget finances a massive expansion of Medicaid and pork projects, such as the purchase of a marina at a state park. "It's hard to imagine Democrats would have spent this much," laments Rob Port, the state's top taxpayer watchdog and creator of the popular political blog, Say Anything.

Texas approved a biennial budget that increases outlays to $106 billion from $84 billion. Florida was so flush with cash that lawmakers increased the state's annual budget by more than 6%, to $74.5 billion. Spending was approved for ballet academies, historic courthouses, river ferries and even funds to help cities keep Major League Baseball teams for spring training. All this in a state governed by Republican Rick Scott with GOP majorities in both houses of the legislature.

Virginia and Maryland passed massive transportation bills, aggregating more than $1 billion, to pay for highways, transit, trains and bike paths. The crown jewel of Democratic Gov. Martin O'Malley's Maryland budget, up 8.5%, was a $1 billion "investment" for the construction of wind farms, financed with new utility surcharges.

In total, state expenditures could rise by 5%-6% this year, according to an analysis by the investment research firm Strategas. That may not seem like a wild spree, but it's running well ahead of the 2% inflation rate.

All of this is financed by an unexpected surge of tax revenues. State income-tax collections through April tax filing rose by 17% over last year, according to the Nelson A. Rockefeller Institute of Government (at the State University of New York, Albany).

But here's the rub. In most non-oil states, revenues are up because tax-filers and companies cashed in one-half trillion dollars of capital gains, dividend and other income at the end of 2012—just ahead of President Barack Obama's federal tax hike. This April's increase in state revenues was in large part a one-time shot in the arm.

As the Rockefeller Institute notes, state revenue growth in the fourth quarter of 2012 (which is part of fiscal year 2013) surged by "25.2%, up from the 6.7% median increase for the first three payments" of the year based on quarterly tax payments. U.S. Treasury data, a lead indicator about state revenues, reveal that non-withheld federal taxes for the April 2013 tax-filing season were up 37% from the same period last year.

Nevertheless, unless the economy picks up significantly and soon, the higher tax collections will not continue. If they don't, then states will be saddled with windmills, ballet centers and transit white elephants they can't afford. This will inevitably prompt new demands for tax hikes.

No state is more prone to this boom-and-bust cycle than California. The Golden State enjoyed a gargantuan 50% rise in income-tax collections in part because citizens approved a ballot initiative that retroactively raised income taxes and also boosted the sales tax starting this year.

The pressures are mounting in Sacramento to spend it all, a temptation that Mr. Brown has pledged to resist. His fellow Democrats seem to have forgotten that the state still faces a $110 billion unfunded pension liability. They also have ignored that the last time they had one-time revenue bonanzas, in the mid-2000s, the money was spent and subsequent state deficits were deeper than ever.

The tendency to take on long-term commitments in response to short-term upticks in revenue is a good reason why states should eliminate or at least flatten their income taxes, as several state governments, including Kansas, North Carolina and Oklahoma, have done this year or last. Indiana, in particular, got its house in order. Republican Gov. Mike Pence held spending to the inflation rate, and the state was able to finance a cut in its income tax and eliminate the estate tax.

Progressive income taxes gyrate much more unpredictably from year to year than sales and property taxes. State sales tax receipts are up only 6% this year, or about one-third as much as income taxes. But sales tax collections didn't collapse in 2008, 2009 and 2010 as catastrophically as did income taxes.

The smart states are reforming their tax codes by flattening tax rates to stabilize revenues and saving for the next rainy day, which always seems to come sooner than the politicians think.

Mr. Moore is a member of the Journal's editorial board.

A version of this article appeared July 5, 2013, on page A11 in the U.S. edition of The Wall Street Journal, with the headline: Christmas Comes Early for State Budgets.