Are The States With The Worst Budget Problems The Product Of Taxes?

How do high-tax and low-tax states fare?


ABC got a big hit on Digg with its list of the Top 10 States With The Worst Budget Problems (but it's actually eleven states). Sifting through the 200 plus comments to the article, I see the usual partisan wrangling: "They're all blue states," says one. "No, this is the result of Reagonomics," says another.

So who's right? Did an obsession with small-government bankrupt these states? Or do they prove that you can't tax yourself into good fiscal standing?

Luckily, we do have at least one good index that measures how "low-tax" states are. The Small Business & Entrepreneurship Council puts out an annual index on the "best to worst" tax systems for entrepreneurship (I've written about it before). What they mean by "best for entrepreneurship" seems to mean how low the whole range of taxes are: personal income, corporate income, capital gains, excise taxes, gas and diesel taxes, whether or not the state taxes Internet access, etc. So the states that do "well" on this index have put these taxes low, or eliminated them altogether. I'm not using this index to make a value judgment on whether or not these policies are good.  I'm just using it as a measurement of low taxes.

How does this ranking compare to ABC's?

Well, it's mixed. Six of the states with the worst budget problems are in the bottom 25 of the SBEC's index--meaning they are high tax. Of those, four come from the bottom 10: California, New York, New Jersey and Vermont. But that still leaves a significant five low-tax states who have major budget woes, and three are from the top 10 of the SBEC index: Alaska, Nevada, and Washington.

That result doesn't really provide ammunition to either side. But things get a little more interesting when we look at personal income tax rates. Here, the five states with the highest personal income taxes in the country all have some of the worst budget problems: in order, California, Vermont, Oregon, New York, and New Jersey. To be fair, Alaska, Nevada and Washington have NO personal income taxes (on the state level only, obviously).

Clearly, there is no strong correlation one way or another here. But that lack of a relationship is more damning for one side of this debate. No one is arguing that low taxes alone can correct a mismanaged budget. For example, low-tax Alaska's deficit is explained by falling oil prices, not taxes. It would seem, however, that if raising taxes to produce more revenue can solve budget problems, you wouldn't see five of the most-taxed states so broke. Those five states seem to be trapped in a tax-and-spend downward spiral.

Such a spiral is not inevitable. High-tax states like Massachusetts aren't in trouble. But if raising taxes won't necessarily make a state's budget situation worse, it certainly does not seem to make things better.