A recent article in the Wall Street Journal covered the extreme reliance of some states on the top 1% of earners by income tax. Nearly 50% of California’s income taxes before the downturn came from the top 1%, households that make $490,000 a year or more. Almost the same statistic applies to Connecticut, New Jersey, and New York.
The problem with this level of reliance is that when the economy goes bust, so do the income of the rich and hence the revenue the state’s taken. Of course state budget deficits have other causes from high unemployment to weak sales tax revenue to the rising cost of healthcare or out-of-control pensions.
We’ve covered in the past that overestimate their revenues, by more than $50 billion in 2009 and spend what they haven’t even taken in. This sounds like the American way, but it is starting to catch up with us.
Proposals like a flatter broader tax or larger rainy day funds would help ease the dependence.
How does all this affect municipal bonds? States and municipalities overspend, creating larger deficits, leading to credit downgrades and possible cash flow problems resulting in falling prices of their municipal bonds. We definitely want to steer clear of these fiscally irresponsible states and municipalities.