Tax Cutting Will Come In Small Packages in '97

More states eye reductions, but the proposals are modest

Less than three weeks into their new legislative sessions, state governments from Boston to Sacramento are awash in proposals to cut levies ranging from property taxes to penalties on married couples.

But think of them more as potential coupons than big cash bonuses.

In the five years since the last recession, many states have built up strong surpluses. Amid sustained economic growth, some have collected more revenues than their constitutions allow and must now offer rebates. But instead of large-scale tax cuts like those in New York and New Jersey in recent years, most of the 29 states now debating reductions are thinking small. Gas-tax cuts in Connecticut, sales-tax rebates in Arkansas.

The primary reason is Washington. As Congress and President Clinton strive to balance the budget and reform entitlement programs, states face a heavier social burden with less federal support. Yet opinion polls still rank taxes as a top concern.

State officials thus appear eager to offer some tax relief, but also hope to maintain strong rainy-day funds to protect against future recession and higher costs to programs like welfare.

"The states are conservative about what they'll give because of federal devolution and the possibility of an economic downturn," says Liz Davis, a tax-policy analyst at the Center for the Study of the States in Albany, N.Y. "There is so much antitax sentiment that states are wary of putting themselves in the position of having to raise taxes again."

Wallet relief from Washington?

The extra $28 you'd receive in New Mexico under Gov. Gary Johnson's proposed $15 million state income-tax cut, however, isn't everything. After two years of bitter confrontation and government shutdowns, Washington also is poised to pass tax relief as part of a deal to balance the federal budget. Senators from both parties have offered tax cuts. So has President Clinton. The overlap - and the will - are significant.

Both sides, for example, favor cutting the tax rate on capital gains. Republicans would lower the maximum rate to 19.8 percent from 28 percent, and index capital gains to inflation. Democrats, who have long resisted cutting this revenue source, now propose exempting up to $500,000 in profits from home sales. They would also allow investors who sell small-business stocks to reinvest earnings without penalty in similar-sized companies.

The two parties in Washington also favor cutting the estate tax and providing families with either a per-child tax credit or a tuition deduction to offset college fees.

Does this amount to more in your pocket? Certainly, the child tax credit would save a family of four $1,000 each year. But the cuts in capital gains, says Robert Reischauer, former director of the Congressional Budget Office, won't mean much for the middle class. The median value of a house in the United States is roughly $100,000. Very few people, he argues, earn big money by selling their homes.

As for the states, the popular tax cut in '97 appears to be the property tax, according to a nationwide survey by the National Conference of State Legislatures (NCSL). Twelve states already have proposals in committee.

There are two main reasons for activity in this arena. Several states cut back on education funding during the last recession, raising the burden of school costs on local governments and property owners. Texas Gov. George W. Bush (R), for example, has proposed cutting property taxes by $3 billion, and would spend $1 billion in surplus revenues - along with earnings from an increased state sales tax - on schools.

In several Western states, property values have risen swiftly in recent years due in part to the influx of new residents. Land values in Montana have climbed 40 percent since a 1993 reappraisal, prompting the legislature this year to consider either direct relief or caps on valuation increases. Wyoming, meanwhile, is considering a constitutional amendment to limit annual property valuation increases.

A handful of other states, such as Arizona and Iowa, are considering income-tax cuts. Most of those measures are modest. Several states are debating reforms or moratoriums to their unemployment taxes.

But overall, most of the large-scale tax cuts at the state level have already been enacted in recent years, and the range of tax cuts at the state level this year is expected to amount to about 1 percent of state tax collections. At the same time, average state revenues grew 2 percent faster than their spending increases. Nine states expect revenues to exceed their budget estimates by 10 percent.

"The states want to hold on to surpluses to the extent that they can," says Scott Mackey, an NCSL tax analyst. "The theme of the year is healthy budgets, strong tax collections, and keeping expenditures on poverty-related programs below budget."

States proceed with caution

In the age of deficit hawks and federal social reform, that approach is probably prudent. Not since the 1970s, experts say, have the states been in such strong economic shape. Most of the Southern states have economies that are much more diverse than even five years ago. Nationwide, federal monetary policy has kept unemployment and inflation stable and low.

But state economies, says Mike Pagano, a political scientist at Miami University in Oxford, Ohio, rely on two revenue sources that are sensitive to fluctuations in the market: income taxes and sales taxes. No one knows for sure how these broader state economies will fare and what impact last year's welfare reforms may have in a downturn.

"I'd be very cautious about counting on a continuation of low unemployment and low inflation," Mr. Reischauer says.

* Robert Bryce in Austin, Texas, contributed to this report.

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