Several states cut a wide variety of taxes this summer. Indiana and Rhode Island, for example, cut the conventional corporate tax. Idaho, meanwhile, took an unconventional route by cutting sales taxes on software purchased through “the cloud.” When revenues are on the rise, some states choose to lower taxes, while others prefer to spend the tax windfall. Both moves could be wrong.
All states except for Vermont must balance their budgets, making state finances very pro-cyclical. In other words, tax revenues rise during good economic times and fall during hard times. The latter can often force policymakers to raise taxes when residents can least afford it.
A wise policy would be to stash budget surpluses in a rainy day fund to help pay for government spending in tough times without raising taxes. Regrettably, policymakers often end up with their hands in the fiscal cookie jar and quickly spend the accumulated surpluses even in good times. Government spending must be low enough and taxes must be high enough to maintain a balanced budget, on average, over many decades.