“The Coming Reset in State Government”

Against the backdrop of the federal march to insolvency, it is fearful to see that many states are following the same path. As Indiana Governor Mitch Daniels wrote in the Wall Street Journal yesterday, “State government finances are a wreck.”

Think things are bad now but will get better as soon as the economy starts growing again? “We ain’t seen nothin’ yet,” says Daniels, a deficit hawk. “It’s … likely that we’re facing a near permanent reduction in state tax revenues that will require us to reduce the size and scope of our state governments.’

Daniels is particularly gloomy about the prospects of states with progressive income tax rates. “California, which extracts more than half its income taxes from a fraction of 1% of its citizens, is extreme but hardly alone in its overreliance on a few, highly mobile taxpayers. Both individuals and businesses are fleeing soak-the-rich states already.”

Bacon’s bottom line: One of Virginia’s relative fiscal strengths is a diversified tax base that does not rely excessively upon one type of tax — be it sales, income or property — to fund state government. Therefore, we can better weather a pronounced downturn that hits one category of tax revenue especially hard. Meanwhile, we need to acknowledge, as Daniels points out, that state revenues are not going to come roaring back any time soon. We should make a virtue of austerity and do serious re-thinking about restructuring how we deliver and pay for state and local government services.