March 31, 2011

In It for the Long Haul: Why Concerns over Personal Income Tax “Volatility” Are Overblown


The precipitous drop in state tax collections during the recent recession has prompted some observers to argue that relying on volatile state taxes is a recipe for budgetary disaster. The most recent version of this argument, made by the Wall Street Journal’s Robert Frank, suggests that the personal income tax in particular is highly volatile, growing dramatically during periods of economic growth and plummeting during recessions. Frank suggests that volatile income taxes make the annual task of budgeting more challenging for state lawmakers, and offers California as a poster child for the dangers of income tax volatility.

But Frank’s analysis misleads in several important ways. First, short-term revenue volatility affects all the major taxes used by states—and it’s not obvious that the income tax is any more volatile than other major taxes. Second, over the long term, progressive income taxes are the most reliable revenue source available to states, displaying more robust growth in the long run than sales, property or excise taxes. Lastly, states faced with revenue volatility have a variety of sensible fiscal management strategies available to mitigate the impact of volatility— and the states that are currently experiencing the greatest budget pain are all too often those that don’t follow these sensible management strategies.

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