Improved state finances — driven largely by an unanticipated bump in revenue collections — reduced the appetite for tax increases in statehouses across the country during 2005 legislative sessions, according to an Aug. 17 report from the National Conference of State Legislatures (NCSL).

State legislative fiscal officers reported year-end surpluses totaling $35.7 billion, double their expectations in what is widely considered a leading indicator of fiscal health. That leaves states with a cushion of 7 percent of states’ total budgets, 2 percentage points more than Wall Street analysts recommend, according to the report released at NCSL’s annual summer meeting.

News was mostly positive for states, which have experienced unprecedented fiscal hardships since the 2001 nationwide economic downturn.

Twenty-three states reported larger year-end surpluses, a measure of states’ general and rainy-day fund revenue, than a year ago. Balances were particularly strong in Idaho, Nebraska and Oklahoma, growing more than 5 percentage points over last year.

Revenue Collections Strong

Robust revenue collections — especially during the second half of the fiscal year that ended June 30 in 46 states — pleasantly surprised lawmakers and allowed some states to avoid large spending cuts and others to begin replenishing their rainy day funds, which took a beating during the fiscal crisis. States’ rainy day funds swelled 14 percent in fiscal 2005.

More money flowing into state coffers meant less impetus for tax increases during 2005 legislative sessions, said the report, which is based on a survey of state legislative budget officers. State lawmakers enacted a net $2.6 billion in new taxes, significantly less than 2004’s $4.1 billion net increase.

The biggest swing came in personal income taxes, which decreased by $329.7 million in 2005 after lawmakers enacted a $1.1 billion increase in 2004.

The trend towards hiking taxes on cigarette and tobacco taxes remained strong in 2005 with a projected net increase of almost $1.1 billion from tax increases in at least seven states.

Lawmakers also increased taxes in all other major categories, although in most cases not as much as in recent years.

NCSL’s president, Maryland Del. John Hurson, a Democrat, said states weathered the recent fiscal crisis with relatively few tax increases over the past few years.

Of the 42 states the provided tax information for the report, Ohio increased taxes the most — more than 5 percent over 2004 levels. Seven other states — Kentucky, Maryland, Minnesota, New Hampshire, New York, Rhode Island and Washington — increased taxes by more than 1 percent. Three states — Idaho, Iowa and Virginia — cut taxes by more than 1 percent.

The report highlights unusual tax changes in several states, including a hurricane-preparedness tax-exemption period in Florida, tax incentives for alternative energy consumption in Florida, Idaho, Indiana, Iowa and Kentucky, and tax relief for military personnel in Arizona, Minnesota and Utah.

On the spending side, increases in Medicaid costs continued to outpace spending growth in other areas. State general fund dollars spent on Medicaid increased 14.8 percent in 2005 and is projected to grow another 7.2 percent in 2006.

General fund spending on K-12 education, which had claimed the largest single portion of total state budgets until eclipsed by Medicaid in 2004, rose 7.6 percent in 2005 and is projected to grow 6 percent in 2006.

The report predicted that higher education spending will grow 5.7 percent in fiscal 2006 and that corrections spending will go up 3.8 percent. General fund support for higher education grew 5.5 percent in 2005, while corrections spending increased 9.3 percent.

Several state legislators and legislative fiscal officers meeting here have expressed concern that state finances might not yet be out of woods, and that this year’s surpluses could soon be eclipsed by spending pressures.

“We might look good, but ask us next year if we ended up good. It might be a different situation,” said Kevin Madigan, Rhode Island’s deputy Senate fiscal adviser. —

Contact Kathleen Hunter at khunter@stateline.org