by Robert Tannenwald
Issue Number 4 — 2001

As recently as a year ago, state governments were awash in revenue, but reports from state revenue officials suggest that growth in tax receipts has slowed considerably in recent quarters. The flow of tax revenues into state coffers has decelerated primarily because the economy has suffered a severe shock (it was weakening even before September 11) and delayed tax cuts enacted in earlier, more prosperous times have taken full effect. However, many tax analysts believe that long-term economic, technological, and political trends are also partially responsible and will continue to constrain state revenue growth even after the economy revives.

This article discusses the impact on state and local revenues of three such trends: the shift in the nation’s mix of production and consumption from goods to services; the proliferation of electronic commerce; and the intensification of interjurisdictional competition. The author concludes that state and local tax systems are, indeed, out-of-sync with the economy’s changing structure. He suggests greater voluntary coordination among tax jurisdictions in tax design and enforcement as the most promising strategy for enhancing revenue productivity. He also notes that more selective use of business tax incentives would help state and local governments to raise adequate revenues without significantly sacrificing other tax policy goals.

Whatever state and local tax reforms are adopted, the author writes, long-run potential threats to the revenue productivity and stability of subnational revenue systems should be continuously reevaluated. With the federal government shifting its priorities in the wake of the attacks on September 11, the states and their municipalities might be called upon to shoulder significantly wider domestic fiscal responsibilities. They should possess revenue systems that will enable them to meet these responsibilities effectively.

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