States' Sorry State Will Pinch Tax Breaks

A variety of other measures were also employed by 29 states, such as refinancing state debt, hiring freezes, tobacco settlement securitization, deferred payments and fund transfers.

But now states are in a bind that would make even MacGyver feel trapped. Even with the $10 billion Congress just grudgingly voted to disseminate to states, federal aid has been steadily shrinking -- states receive 20% of their budget from the federal government, down from 25% some 25 years ago.

The states are also facing increased costs foisted on them by federal dictum, such as rising cost of Medicaid and homeland security. A high rate of unemployment (last measured at 6.9%) means more spending (unemployment insurance) and a lower tax base (fewer people working and spending). And let's not forget the tax cut; 17 states have their income tax linked directly to federal forms. That means that if federal taxable income declines, so will state.

All of this adds up to big problems for 2004, including a projected combined shortfall of $80 billion, or about 15% of states' total budgets. "States are facing some very serious problems," says Keon Chi, a senior fellow at the Council of State Governments. "And now they are going to have to raise revenue by raising taxes."

Indeed, some 30 to 35 states have already begun raising taxes, although none have raised income tax. "States began by raising cigarette taxes and tacking on added fees for everything they could," says Greg Von Behren, a staff associate at NASBO. "But now they're running out of options and will have to look at broader taxes, like sales tax."

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