July 6, 2000 --The 1990s were good for most states. But with economies cooling nationwide, the public policy research arm of the State University of New York says tougher times are ahead.

A new report from the Nelson A. Rockefeller Institute of Government in Albany, N.Y., says the biggest threats to state governments are reliance on "volatile" personal income taxes and loss of sales tax revenue.

In State Fiscal Issues and Risks at the Start of a New Century, Donald Boyd, director of the Fiscal Studies Program at the Institute, found that income and sales taxes account for the bulk of state money, with each representing about 18 percent of general revenue. But the growth of income tax collections over the last decade has a dark side.

Volatile income taxes
Most state income tax systems, like the federal one, are progressive, meaning higher income earners pay more tax. These higher incomes, however, tend to be more volatile, Boyd says, because the money often is produced from economy sensitive sources such as capital gains.

These earners also have considerable control over how and when taxes are levied because they can decide when and how much of their investments to sell. So when the business cycle is up, there is rapid income -- and tax collection -- growth, but downturns in income and taxes are just as swift when the economy stumbles.

The 10 states determined by the Institute to be most at risk if taxpayers earn lower capital gains, and subsequently less income to tax, are Colorado, Oregon, New York, Connecticut, California, Minnesota, Massachusetts, Virginia, Idaho and Maryland.

Sales tax collections expected to fall
In the sales tax area, Boyd expects a long-term decline in that tax base for three reasons:

1. Consumption has been steadily shifting from goods toward services. And within the service category, the growth is in medical and other services that are difficult to tax politically, legally and administratively.
2. Remote sales, such as mail order and Internet transactions where buyer and seller do business at a distance, are increasing. Politicians continue to argue over ways to equitably collect sales taxes in the states, but the reality is that not much of this revenue ever finds its way into state treasuries.
   States particularly vulnerable to tax losses because of electronic commerce, according to the report, are Nevada, Florida, Texas, Tennessee, Washington and Mississippi.
3. State lawmakers themselves undercut collecting authority by increasing the number of items exempt from sales tax.

Good luck and good planning
From the perspective of fiscal stability, the report concludes, states were both lucky and good during the last decade when it came to collecting money. They were lucky that a booming economy grew faster than expected and fast enough to more than make up for structural weaknesses in state revenue basis. And they were good because they rebuilt reserves to a 20-year high after the last recession.

But the rapid income and sales tax growth of the 1990s is "almost certainly unsustainable" and likely to slow sharply in coming years, Boyd warns. Now is the time for state officials to take long hard looks at ways to make up tax losses in the coming years.