Tax Foundation: State governments seeking to increase excise taxes to cover budget deficits is ‘bad tax policy’

By Bethany Blankley | The Center Square

State governments considering increasing excise taxes to backfill revenue failures and pay for increased expenses due to the economic impact of the coronavirus shutdown is “bad tax policy,” according to an analysis by the Washington, D.C.-based Tax Foundation.

The coronavirus-induced economic crisis has impacted “almost every meaningful source of state revenue,” Ulrik Boesen from the Tax Foundation says in a new report published on state deficits.

States are looking at significantly reduced or eliminated revenue from excise taxes, which are directly linked to spending. The less consumers spend on travel the less they pay in gas taxes, and excise taxes on tourism and hospitality industry-related purchases. Closures of casinos, bars, and other establishments responsible for considerable “sin tax” revenue (alcohol, cigarettes, gambling and marijuana) will also impact states’ bottom lines, the report notes.

“Historically, income taxes are more volatile than sales and excise taxes and fall more sharply during a recession, but this crisis is unique inasmuch as social distancing and shelter-in-place orders, along with mandatory closures of many nonessential businesses, have led to a sharp contraction of consumer spending,” Boesen adds. “Moreover, the goods and services seeing spikes in demand, like groceries and digital entertainment, are less likely to be subject to state sales tax.”

State governments are not only facing “extraordinary uncertainty about the depth and duration of this crisis,” but must also fund budget priorities with less revenue. “The longer lockdowns continue, the more severe the economic downturn, not just due to a longer initial period of economic contraction, but also due to a reduction of business capital and a breakdown in supply chains, which will make it more difficult for businesses to return operations to pre-coronavirus levels,” Boesen says.

In the first two quarters of 2019, states collected $26 billion in gas taxes, $3.5 billion in alcohol taxes, $4 billion in amusement taxes, and $9 billion in tobacco taxes – a total of $42.5 billion total, according to the Tax Foundation analysis. A conservative expectation that states lose at least 10 percent in excise tax revenue in each of these categories would leave them with a shortfall of roughly $4.25 billion, the report projects.

To stabilize failing state budgets, the National Governors Association called on Congress to pass another stimulus bill – this time for $500 billion just for state governments.

NGA chairman, Republican Maryland Gov. Larry Hogan, and the NGA vice chairman, Democrat New York Gov. Andrew Cuomo, said in a joint statement, “In the absence of unrestricted fiscal support of at least $500 billion from the federal government, states will have to confront the prospect of significant reductions to critically important services all across this country, hampering public health, the economic recovery, and – in turn – our collective effort to get people back to work.”

“States need to take action to get their own fiscal house in order before they raise taxes or ask the federal government for more help beyond the $150 billion they have received,” Michael Lucci, president and publisher of 50economy.org, told The Center Square.

“It’s too early to know what states need, and it’s too early to see what states can do to fix the problem on their own,” Lucci adds. “Raising taxes in a recession is a bad idea, regardless of what tax it is.”

Instead, he argues that states should cut costs in areas outside of emergency response efforts.

Traditionally, excise taxes are raised in times of crisis, Boesen says, because they are easier to implement and affect smaller groups of constituencies, like those using tobacco, alcohol or marijuana products. Excise taxes are politically easier to increase than taxes on income, sales or property. But Boesen argues that “excise tax revenues are volatile, non-neutral, and often regressive,” which is why increasing them to fill budget holes is “bad tax policy.”

The report also adds that new revenue opportunities on marijuana sales and sports betting shouldn’t be increased because they are “highly unlikely to raise much revenue in the short term.”

Ultimately, revenue collected through excise taxes should be allocated to spending related to the taxed activity or good, Boesen says. Excise taxes “are too volatile and unreliable to rely on for long-term budget priorities.”