Federal Budget Cuts Will Bring State Tax Hikes

Though recession is visible only in the rearview mirror, many states will continue to travel a bumpy budget road, perhaps for much of the decade.

The worst is over, but sluggish economic growth is still keeping primary tax revenue streams at a trickle. And with the mandatory federal spending cuts imposed under sequestration, states can't look to Washington for another nickel. The sequester will cost states $6 billion in federal funds, on top of other federal aid that has already disappeared.

About 30 states faced a combined shortfall of $40 billion this year. Two-thirds of those will still be in the red in 2014, about $25 billion shy of balanced budgets. It's much better than the $71-billion gap two years ago, to be sure, but still far from when many states had surpluses.

Subscribe to Kiplinger’s Personal Finance

Be a smarter, better informed investor.

Save up to 74%

Sign up for Kiplinger’s Free E-Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

Sign up

Improving economies will help over time, as hiring and growth boost tax revenues and federal funds start flowing to the states again. But states don't have the luxury of time. Unlike the federal government, states can't ignore deficits, because they are required to balance their budgets each year.

Unless you live in a state that's flush, such as energy-rich Alaska, Utah, Texas or North Dakota, expect to see deep cuts to programs, more layoffs and tax increases that will increase costs for businesses and consumers.

"State tax systems are ill-equipped to raise revenue in a 21st century economy,” analysts for the Center on Budget and Policy Priorities noted in a recent report. "State revenues remain deeply damaged by the recent recession, which was the worst downturn for states in 70 years. While revenues have improved recently, funding levels remain far below pre-recession levels and reserve funds need replenishing, making it very hard for states to strengthen key services."

Most state income tax rates will stay the same. Many rates have risen since the recession, and state officials worry about the economic impact of a new round of increases. Instead, consumption taxes and fees will go up in many locations.

Motorists will be hit especially hard: At least 17 states will raise gas taxes this year. The new levies will pinch businesses that rely on shipping or that transport goods — costs that'll be passed along in the form of higher prices to consumers and merchants. Drivers will also confront steeper fines and stepped-up enforcement of traffic laws by determined ticket-writing police and through greater use of cameras to nab speeders and red-light runners.

Sales taxes are the low-hanging fruit in the search for additional revenue. Florida, looking to get ahead of a federal push, is among states weighing a levy on out-of-state online sales. Sin taxes are an easy target, too. The price of cigarettes could rise in parts of Oregon; booze may cost more in Philadelphia; and West Virginia wants to keep a bigger chunk of lottery winnings. Sugar is the new face of consumer evil that states will use to raise revenue. In Massachusetts, soda and candy soon won't be considered groceries anymore and will be heavily taxed.

Some local governments seek more user fees instead of higher property taxes. There's talk in Washington, D.C., for one, of a fee to register bicycles for folks using bike lanes. Elsewhere, watch for heftier charges for permits to use local parks or municipal tennis courts.

And don't be surprised by more ballot measures aimed at making money. In the cards: New casinos or gambling initiatives in some jurisdictions, plus growth in efforts to legalize marijuana. Both ventures would be heavily taxed and regulated, and could bring in the big bucks.

The pain will be sharpest in big states that bore the brunt of the recession — California, Michigan, Pennsylvania and Illinois — along with states with a large military presence, such as Virginia, North Carolina, South Carolina and Florida. They'll feel the bite of automatic federal cuts squeezing the Pentagon and contractors.

Some discomfort will linger just about everywhere. Since the recession, 43 states have tinkered with public pensions and 46 have reduced or dropped services.