What State Reactions to Previous Recessions Tell Us about Taxes Post-Coronavirus

There is a justifiable concern that when state lawmakers eventually return to tackle state budgets, they will be forced to raise taxes significantly in order to meet their balanced budget requirements. Given the scale of the COVID-19 crisis, it’s hard to predict exactly how states will react, but it’s edifying to review what states have done in recent economic downturns.

Using an archive of the National Conference of State Legislature’s (NCSL) annual State Tax Action reports, we analyzed the five most populous states (California, Texas, Florida, New York, and Pennsylvania) in the three years following the onset of the “dot com” recession of 2001 and the “Great Recession” of 2007. We found that far from acting quickly and deliberately to raise new revenues, states had a delayed response and used a myriad of different tools to achieve a range of revenue goals.  

While reviewing five states over the course of six legislative sessions doesn’t give a definitive picture of governmental recession responses, it does start to reveal a pattern of how states have handled these situations in the past. Specifically, we find that states tend to take several months, if not a full year after the onset of a recession before they enacted significant new taxes. Additionally, the extent of a state’s response varies based on the scope of the economic calamity and the political culture of that state. Finally, when choosing policy solutions, politicians tend to pass limited, politically achievable policies rather than broad tax reform packages that drive the tax policy in a specific ideological direction. 

States Need Time to Act

States are generally slow to adopt significant new taxes in response to economic contractions. In 2001, the five states we considered in this analysis (California, Texas, Florida, New York, and Pennsylvania)  actually enacted tax cuts that, on average, reduced their revenue collections by $86 million. This is understandable — those actions were taken prior to the full force of the recession hitting state revenues. A year later, these states passed laws increasing tax collections by an average of $629.1 million.

Similarly, in 2008, the year following the onset of the Great Recession, the four states that were in legislative session (Texas did not meet in 2008) increased taxes by an average of $574 million. By 2009 the five states total had increased taxes by $4 billion. But this spike in new taxes was limited to the year or two after the onset of these recessions. In 2003, tax increases in these five states averaged $162 million, and in 2010 the average in new taxes was $234 million in 2010 (New York bucks this trend somewhat in that their new revenues increased slightly from 2001 to 2002, but increased sharply in 2003).

In other words, these five states: (1) in the first year after the recession began, enacted few new taxes; (2) in the third or second year following the recession, enacted new taxes, with variability based on political orientation; and (3) in the third year after the recession, enacted relatively few new taxes. (If we carried our analysis forward, we know from the Great Recession and subsequent partisan changes in many legislatures in 2011 that significant tax reductions followed. But that is beyond the scope of this analysis.)

The timing of when the National Bureau of Economic Research (NBER) declared these two recessions also seems to have had a small impact on the timing of future tax increases (read about their recession dating process here). The dot com bust materialized in March 2001 and the Great Recession technically began in December 2007. With the former occurring in the middle of the legislative session, state lawmakers may not have had the time to muster the necessary political will or economic data to find an appropriate response. Since the Great Recession began before the formal beginning of the state legislative season, states had more opportunity to get their arms around the problem before they started legislating, although it was not obvious at the time the country was in recession. (Recessions are dated after the fact in most cases.)

Turning to the current economic downturn caused by the pandemic, we do not expect states broadly to consider significant tax increases prior to the November elections. Significant tax increases are not likely to be on the table until after the elections, whether via special sessions late in 2020 or during states’ regular sessions in 2021. The question of scale of future tax increases remains unknown, due in part to uncertainty regarding the timing and strength of the economic recovery and, in part, to uncertainty regarding the full scope of  congressional financial  support for state and local governments. It remains to be seen whether the timing of the onset of this recession and the additional “lead time” it provides to legislators will affect the ultimate timing of tax increases.  

State Responses Are Proportionate to the Crisis 

The scale of a state’s response to a recession seems to depend, perhaps unsurprisingly, on the extent of the recession’s economic impact and the partisan composition of the governments involved. The Great Recession shaved 4.1 percent off of national GDP, compared to 0.6 percent that was lost from the dot com bubble. This disparity is also evident in the policies that these five states enacted: they sought an average of $433 million in new revenues over the three years following the dot com recession compared to an average of $1.6 billion per year after the Great Recession. States are sensitive to the scale of the problem they face and will tend to adopt policies in line with those challenges, rather than seeking to raise revenue to capitalize on the political opportunity to do so. 

But these averages mask massive state to state differences. In the wake of the Great Recession, the vast majority of tax increases came from California and New York, which together increased taxes by $21 billion over three years compared to a total of $2.6 billion in tax increases from Texas, Florida, and Pennsylvania. A similar disparity is present following the dot com recession, with New York and California collectively increasing taxes by a total of $4.9 billion, compared to $1.4 billion from Texas, Florida, and Pennsylvania.

An April Mercatus study estimated that the American economy could lose five points off GDP for each month the economy is partially shut down, which suggests a potential economic impact several times larger than what was experienced after the 2008 crash. Looking at the historical data it seems clear that lawmakers, particularly in states where Democrats exert greater legislative control, could seek to raise new revenue at historic levels. 

Enacted State Policies Tend to Favor Political Expediency 

NCSL identifies approximately 80 enacted laws increasing revenue from these five states over a six year period, compared to roughly 40 enacted laws reducing taxes. This shows the contrasting goals that states try to achieve after an economic shock: states need more money to fund services, but they also want to bolster taxpayers with tax cuts and incentives programs. Rather than approach this problem in a systematic way, however, states appear to take a more scattershot approach of enacting those policies that are available and politically expedient. Given that politics is the art of the possible, perhaps that shouldn’t be surprising, but it’s notable that there aren’t more examples of states seeing an economic crisis as an opportunity to make more long-term, fundamental changes to their revenue systems.   

For example, states typically raised the most money when they increased the rate for one of their main tax types, but this only occurred four times: California increased the sales tax rate temporarily in 2009, New York raised its sales tax rate and levied a tax on upper-income individuals in 2003, and Pennsylvania raised its personal income tax rate in 2003. By contrast, there are about ten instances where states notably increased fees and ten where they increased “sin taxes” on things like gambling, tobacco, and alcohol. This isn’t to say that states should have increased tax rates more and cigarette taxes less, but it is notable that lawmakers were far more comfortable with one of these options than the other. 

Political orientation and ideology also have significant bearing on these matters. After the Great Recession, for example, California and New York imposed significantly more new revenue liabilities than Florida, Pennsylvania, and Texas combined. 

(It is important to note, however, that the partisan control of these states was different than it is now. New York Republicans controlled the Senate and governorship during the post-dot com years as well as the Senate during the Great Recession. Similarly, Governor Arnold Schwarzenegger (R) was in office in California during the aftermath of the Great Recession and Democrats held the Texas House from 2001-2002.)

We also expected to see more states eliminating tax credits or exemptions,  but the record does not bear this out. There are very few instances where NCSL reports that states sought to find real savings this way. (California’s repeated suspension of the net operating loss deduction — which has already been proposed as a response to the current crisis in California — is a notable exception. Although a suspension is not a repeal.) 

Finally, when states adopted tax relief, the benefits were spread over a relatively wide range of industry sectors, but when they levied new targeted taxes, they typically turned to two specific industries. The record shows roughly nine instances where states sought to give specific help to a portion of the private sector, including California enacting tax cuts for farmers and truckers in 2001, New York beefing up its film tax credits in 2008 and 2010, and Florida enacting insurance industry tax exemptions in 2002. By contrast, the healthcare and telecommunications industries saw 11 new taxes targeted specifically at them during this period.

When looking ahead, we shouldn’t expect state lawmakers to use a public health crisis as an excuse to fundamentally reorient their tax structures. They are more likely to pass what they need to, and what they can, in the hopes of keeping the state fiscally intact until underlying economic conditions improve. 

Bookmark our COVID-19 Policy Tracker and Dashboard here, which monitors coronavirus response by state: multistate.us/pages/covid-19-policy-tracker.