Montana Viewpoint

October 14, 2002

Montana has big budget problems, but so do 39 other states. The universal problem is they overestimated the amount of revenue they would take in and based their spending on that inflated estimate. But 40 states? All at the same time? How could that happen?

State governments base their spending level on the amount of revenue they expect to take in from all sources: income, property, and sales taxes; mineral taxes on oil, coal, silver, etc.; fees, fines, and on and on and on. Most states begin the revenue estimating process the year before their legislature meets, and it can be a long, drawn out procedure. Many states subscribe to a major economic forecasting firm, and rely on their information as to how the economy will behave.

When the legislature meets, the Revenue Estimate is officially adopted and becomes the basis for how much money the state will be able to use to fund government programs: education, healthcare, highway patrol, etc.

Over the past several years, as the stock market soared to new heights, one element of the states’ revenue picture out-performed all others, and by a great deal. That was the capital gains portion of the Income Tax. As capital gains taxes increased state revenues over the course of the stock market buildup, the states spent more. I assume they thought it would last forever, but like all good things, and some bad ones, it didn’t.

The corporate scandals and incredible meltdown of major U. S. corporations was the beginning of the downturn, and the disaster of September 11, 2001, was the nail in the economic coffin. Income tax collections plummeted because of a severe drop in capital gains tax receipts, and most state economies took a serious downturn, increasing the stress on already fragile budgets.

In Montana, drastically lower capital gains tax collections helped drive us to a $300 million budget deficit. Whatever you might feel about the state of the Montana economy, Montana did not take part in the recession that was hammering other states. This was made clear by Paul Polzin of the Bureau of Business and Economic Research at the University of Montana in a presentation to a legislative committee.

I was curious about two things: why did the recession bypass Montana, and why did states without income taxes get into the same budget crisis as income tax states. After all, if the nosedive in capital gains was the main factor in most states, shouldn’t states without income tax be protected against a downturn in revenues? I called Mr. Polzin to get some answers.

The short and sweet answer to the first concern was that Montana didn’t have much of an economy to turn down. Tourism did take an awful hit nationwide after September 11th, but by that time Montana’s tourism season was ending anyway. So, we escaped the recession by not having any large industries that were affected by it.

States without income tax got hit for different reasons, but they got hit hard. Florida and Nevada saw tourism plummet. While Florida relies on taxes generates by tourism, especially the sales tax, Nevada’s lifeblood is the gambling tourist. In Nevada, gambling taxes pay the freight, and they collapsed. Other states had their manufacturing sectors hard hit by the recession; for instance, Washington saw a downturn in the aircraft industry.

The bottom line is, nobody saw it coming, and the downturn was so severe that the rainy day funds of most states weren’t big enough to fully cover the losses. States treated a capital gains tax bubble as a permanent and forever growing source of income, and budgeted accordingly. Revenue projections were made on schedule, but well before the downturn occurred, and reflected a bright and rosy picture.

So, now we know what it feels like to get caught unprepared. We can’t stop bad economic times from happening, but will we do anything to guard against being caught off guard?

Jim Elliott
Phone: 406-444-1556
Mail: State Senate Helena, MT 59620