Reform Amid Fiscal Ruin

In October 2007, two months before the onset of the worst U.S. recession since the Great Depression, Maryland's Democratic governor, Martin O'Malley, convened a special session of his state's Democrat-controlled General Assembly in a high-stakes effort to close an unexpectedly large $1.7 billion budgetary shortfall. A central component of O'Malley's proposal was converting the state's flat income tax of 4.75 percent to a progressive system with higher brackets of 6 percent and 6.5 percent for upper-income households. At the same time, he advocated a combination of tax hikes on corporate income, sales, tobacco, and vehicle titles, along with reductions in taxes on property and the incomes of lower earners.

The progressivity of O'Malley's plan was somewhat weakened as the negotiating process unfolded, largely through the interventions of legislators representing Montgomery County and its influential minority of multimillionaires. Nonetheless, the final budget reduced income taxes for lower- and middle-income taxpayers while adding three new rates ranging from 5 percent to 5.5 percent on incomes from $150,000 to $1 million for single individuals and $200,000 to $1 million for married couples. In addition to those permanent changes, incomes over $1 million would be taxed at 6.25 percent for three years, beginning in 2008. At the same time, the newly balanced budget actually provided more funding to extend health-care coverage to 100,000 lower-income residents, build public schools, clean up the Chesapeake Bay, and invest in transportation infrastructure. The liberal columnist E.J. Dionne Jr., in a Washington Post column titled "A Governor Unafraid of Government," wrote, "The sound you are hearing not only in Maryland but in state capitals across the nation is the crashing and crumbling of ideology, specifically a right-wing ideology that demonizes taxes and government while preaching that the public interest depends upon solicitude toward the comfortable and the privileged."

Dionne's pronouncement describes only a minority of states, but the experience of Maryland and several other states does suggest that a progressive fiscal politics is indeed possible as states face a deepening budget crisis.

As the recession unfolded, with state tax receipts plummeting at the steepest rate on record, at least six other states entirely or predominantly under Democratic control followed O'Malley's leadership and soaked the rich to help close budget gaps while minimizing cuts to basic public services. Unfortunately, the downturn has been so severe that even the most progressive state governments have been unable to completely avoid painful spending reductions and tax hikes on average citizens, notwithstanding federal stimulus support that modestly helped to soften those blows. Still, the efforts in those seven states to recalibrate their tax systems during the ongoing crisis are an important and welcome change.

Prior to O'Malley's initiative in Maryland, the only other states to institute higher income-tax rates on upper-income residents were New York in 2003 and California and New Jersey in 2004. In general, the financing of state governments has always been highly regressive, loaded most heavily on the backs of low- and middle-income families through sales, sin, and flat income taxes, supplemented by lottery and other gambling revenues. In addition to promoting fairness by shifting the burden onto high earners who prospered most during this era of rising inequality, taxing the wealthy is the least economically damaging way for states to meet their legal obligation to keep their budgets in balance during a recession. Not surprisingly, a regressive tax structure feeds the climate of revolt against taxes. Altering that psychology requires taxation based on the ability to pay.

Beyond Maryland, the story so far in the six other states that added new income-tax brackets for high earners, in brief: 

In late June, the state's Democratic governor, Jim Doyle, signed a budget that closed a $6.6 billion, two-year shortfall in part by creating a 7.75 percent income-tax bracket on earnings over $300,000 for married couples and $225,000 for individuals. In addition, he cut in half the tax exemption on capital-gains income, which almost entirely affects upper-income households. Together those changes were expected to raise $529 million over the two-year budget window. Thanks as well to $2.2 billion in federal stimulus aid, Doyle and his Democrat-controlled Legislature were able to avoid deep reductions in school funding while still reducing state spending by more than $3 billion through steps like across-the-board cuts to state agencies. Although Wisconsin's unemployment rate soared from 4.7 percent in September 2008 to 8.3 percent a year later due mainly to a surge in manufacturing job losses, the bleeding appears to have stopped at a level well below the national average -- at least for the moment. Doyle announced that he won't be seeking a third term, saying that he doesn't believe elected executives should serve more than two terms: "I know that I will regret this decision many times over the coming year, but I am not going to pull a Brett Favre on you."

"I will be the first to tell you I do not think Oregon is California," said Gov. Ted Kulongoski, a Democrat, as he signed a budget that included higher tax brackets on upper-income households and increases in corporate taxes. By efficiently approving legislation that largely avoided the stalemates and draconian cuts to public services implemented in its neighbor to the south, Oregon's response to its own huge deficit and one of the highest unemployment rates in the country was indeed a stark contrast to the Golden State's actions. But like California, Oregon is unusually reliant on voter referenda, and the $733 million in tax hikes are subject to public approval on Jan. 26.

Backed by business lobbies and anti-tax groups, the ballot measures would abrogate the transformation of Oregon's income tax from a flat 9 percent to one that adds brackets of 10.8 percent for married couples earning between $250,000 and $500,000, and 11 percent for couples earning over $500,000. (After 2011, the top rate would drop to 9.9 percent.) Largely because of federal stimulus aid that has been spent more rapidly and effectively than in other states, Oregon's unemployment rate dropped from a peak of 12 percent to a still-high 11.1 percent. The state's term-limit law prevents Kulongoski from running for a third consecutive tour of duty, but the January vote will be a revealing test of progressive taxation's popularity.

North Carolina.
In this once stalwart conservative state, Gov. Bev Perdue, a Democrat, and the two Democrat--controlled chambers of the state Legislature jousted for more than a month beyond the July 1 fiscal year deadline to settle on a budget that received no Republican votes. Their agreement added a tax surcharge of 2 percent for married couples with incomes between $100,000 and $250,000 and single filers with incomes between $60,000 and $150,000. The additional rate is 3 percent above those thresholds, with the surcharges applying only for 2009 and 2010. A 1-cent increase in the sales tax was also approved. The main sticking points between Perdue and the Legislature related to her preference for higher taxes in exchange for more support for education and other public services. Perdue, who was elected last year, quickly lost popularity as layoffs in the state's manufacturing sector knocked the unemployment rate up to the 11 percent range. But one poll after the budget agreement was reached showed her approval rating bouncing up 14 points to 43 percent.

This state's Democrat-controlled Legislature ultimately carried the day against popular Gov. M. Jodi Rell, a Republican, after the longest budget battle in the state's history, which dragged on for two months into the new fiscal year. In addition to a dollar increase in the cigarette tax, the new budget included an increase in the top bracket from 5 percent to 6.5 percent for individuals with incomes over $500,000 and married couples filing jointly in excess of $1 million. The Legislature fended off most of the deep cuts to a wide range of programs that Rell had sought, but the budget also included many accounting maneuvers that may come home to roost before long. Soon after the budget became law without her signature, Rell announced that she would not be running for re-election in 2010 even though her approval ratings remain well above 50 percent. Democrat William Curry, who lost the governor's race in 2002, told the Hartford Courant, "She may have won the prize for least ideological Republican of her generation, and that went over big in Connecticut." Even still, she steadfastly opposed the millionaire's tax and tried unsuccessfully to repeal the state's estate tax.

New York.
Although it's difficult to find reason to applaud the Empire State's notoriously dysfunctional and sometimes clownish Legislature, its Democratic leadership deserves credit for pushing through new top brackets for high earners that are scheduled to remain in place for three years. The rate was raised from 6.85 percent to 7.85 percent for individuals with income between $200,000 and $500,000, and for married couples filing jointly with income between $300,000 and $500,000. Regardless of filing status, the new rate on income above $500,000 is 8.97 percent. Since that budget was approved in March, the state's fiscal condition has continued to deteriorate along with the state's economy. At this point, the unpopular Democratic governor, David Paterson, who resisted the higher upper-income tax rates, is acting more responsibly by trying to push a recalcitrant state Senate to address a deficit that's already back up to $3.2 billion.

The Aloha State's heavily Democratic Legislature overrode Republican Gov. Linda Lingle's veto of tax increases, which included the imposition of the highest state-level income-tax rate in the country. The top rate was raised from 8.25 percent to 9 percent for married couples with income between $300,000 and $350,000; 10 percent for income between $350,000 and $400,000; and 11 percent for income above $400,000. In addition, the state's standard deduction and the personal exemption were increased by 10 percent, reducing the taxes owed by low- and moderate-income families. As in most other states, new budget gaps have quickly emerged since the deal for the current fiscal year was reached. In Hawaii, where declining tourism has pushed the unemployment rate to 7 percent, Lingle recently vowed again to draw the line against additional tax increases.

New Jersey.
Gov. Jon Corzine's defeat in November to Republican Chris Christie can be blamed on a lot of factors, foremost among them the state's weak economy and hostility toward high property taxes. Relatively low on the list was the increase in upper-income tax brackets that the Democrat-controlled Legislature approved and Corzine signed in June as part of their budget agreement. For one year only, income-tax rates on households with incomes above $400,000 will rise, with the top level on earnings above $1 million increasing from 8.97 percent to 10.75 percent. another piece of good news related to state taxes during this otherwise dismal economic period was the defeat in both Maine and Washington of the tax and spending limitation of the so-called Taxpayer's Bill of Rights [See Iris J. Lav and Jon Shure, "Loosening Fiscal Straitjackets,"] -- a referendum that Grover Norquist and other anti-government zealots have pushed onto state ballots over the years. Largely because TABOR proved to be so disastrous in Colorado, the one state where it was fully in effect for an extended period, none of the 20 states that have considered TABOR constraints since 2004 have adopted them. The wreckage that became of Colorado's public services and fiscal condition has proved to be compelling evidence against TABOR's rigid strictures on state fiscal policies. (Maine also deserves credit for overhauling its tax system in ways that make it more equitable and progressive.)

Reform depends on the presence of courageous state officials and on-the-ground advocacy groups to contest the permanent influence of business lobbies. In these recent reform efforts, progressive policy and grass-roots groups worked closely with legislative allies and conducted sophisticated public-education and outreach campaigns.

In Wisconsin, a broad-based coalition led by groups like the Wisconsin Council on Children and Families and the Institute for Wisconsin's Future created a catalog of revenue options that it advocated to the governor and legislative leaders. The coalition held forums statewide to advance these proposals and directed advocacy efforts in key legislative districts. Further, it held rallies at the state Capitol to show support for the efforts.

In Maryland, at the request of legislative leadership, the Maryland Budget and Tax Policy Institute, the Maryland Council of Nonprofits, and other organizing groups conducted analysis and delivered testimony to legislative committees on the need to advance revenue proposals. They worked with members who were on the fence to make the case for revenues.

In Oregon, progressive groups conducted extensive polling to gauge public attitudes relative to revenue options. They used this information to help craft messaging and guide policy options that were ultimately advanced by the Legislature. The coalition Our Oregon is resisting the repeal campaign, making the case to the public that these measures are a necessary and reasonable part of a balanced solution to the state's budget crisis.

Elsewhere, coalitions like Together for North Carolina, the Better Choices campaign in New Jersey, and New Yorkers for Fiscal Fairness came together to advance revenue proposals. They directed sophisticated, targeted campaigns that included placing letters to the editor, phone banking, coordinating local constituent meetings with legislators, and organizing rallies at states' capitols. Ultimately, these public-education efforts were very successful. In many cases the revenue proposals promoted by the coalitions came from members of the State Fiscal Analysis Initiative, like the Fiscal Policy Institute in New York, New Jersey Policy Perspective, and the North Carolina Budget and Tax Center.

Although the worst of the recession is winding down, populous states are expected to confront an ongoing budget squeeze for years to come. State and local tax revenues are likely to remain meager, the share of the population relying on state and local services will be high, health-care and educational costs will continue to soar, state pension plans will remain badly underfunded, and the federal stimulus money that staved off disaster will run out unless Congress passes bolder emergency aid. In that climate, governors and state legislatures can't on their own fix a system of federalism that is rapidly breaking down. But, as demonstrated during the immediate crisis, they can act to shift the burden of financing state government more toward residents who are best able to afford higher taxes. In a small but meaningful way, that's progress.