States bank big money while the Fed tries to fight inflation

JEFFERSON CITY, Mo. (AP) – State governments emerging from the coronavirus pandemic built historic cash surpluses as inflation in prices and wages drove up revenue and income taxes.

Now many states are reaping another reward: banking millions of dollars on those profits while the Federal Reserve fights inflation with higher interest rates.

“We’re catching both ends of it,” said Missouri Treasurer Scott Fitzpatrick, a Republican.

First, “we received a lot of extra money,” he said. “Now, nominally, we’re benefiting from the rate hike from the Fed.”

Missouri is hardly alone. States ranging from Democratic-led Massachusetts to Republican-led Texas as well as politically divided Minnesota are all sitting on large surpluses, swelling even more thanks to favorable interest rates on investments.

As lawmakers prepare for their 2023 sessions, governors and lawmakers are proposing to tap those surpluses to cover tax cuts and greater spending on priorities like infrastructure and education. Although most states can afford it, financial experts nevertheless urge caution due to concern that the US could slip into a recession.

“Some of this is what I call a sugar high,” said Phil Dean, chief economist and public finance researcher at the University of Utah’s Gardner Policy Institute. “The growth rates are definitely not sustainable.”

California can be a harbinger of economic trends. After projecting an unprecedented $97 billion surplus just seven months ago, state officials are now expects a deficit of about $25 billion in the next budget. California taxes the rich higher than most states, leading to pendulum-like swings in tax revenue as the stock market rises and falls.

State budgets have been working through unusually uncertain times since the coronavirus pandemic began in early 2020. As governors ordered shutdowns to try to slow the spread of the virus, layoffs skyrocketed and states braced for huge revenue losses. But federal relief payments put money in people’s pockets, labor markets rebounded, and the deep downturn was short-lived.

The state’s tax revenue rose far beyond expectations. After several years of double-digit percentage growth in revenue, the states ended their 2022 fiscal year with a record cash balance of nearly $343 billionaccording to the National Association of Government Budget Officers.

“The budgets are really strong — historically strong,” said Tim Storey, executive director of the National Conference of State Legislatures, as he previewed the upcoming legislative sessions.

Large profits enable states to take advantage The Federal Reserve raised its benchmark interest rate interest rates seven times over the past year, making many loans more expensive in an effort to curb consumption and fight inflation.

Texas had expected a $27 billion surplus for its current budget, boosted by strong sales taxes and energy revenue. That will likely rise to more than $30 billion when a revised revenue estimate is released in January, said Tom Currah, associate deputy comptroller for fiscal affairs. That’s a larger surplus than the annual general fund expenditures of 40 other states.

Republican Governor Greg Abbott promised during his re-election campaign that half of the surplus would go to property tax relief.

Rising tax revenue in Massachusetts this year triggered a rarely used state law demands that $2.9 billion be returned to taxpayers. Large cash balances allowed the state to collect nearly $57 million in interest in October alone — six times the amount earned during the entire 2021 fiscal year.

Minnesota projects a record profit of 17.6 billion dollars for the next budget. A strong economy, with one of the lowest unemployment rates in the country, pushed individual incomes, sales and corporate tax revenues higher than originally expected. Political crisis added to the bulging coffers as the Republican-controlled Senate and Democratic-led House could not agree on how to spend all the extra money.

Thanks to higher interest on the huge surplus, Minnesota expects investment earnings of $428 million this fiscal year — a whopping 1,427% increase over a previous estimate.

Democrats who won the fall election will have full control of Minnesota government by 2023. Gov. Tim Walz said the surplus could be used to provide tax breaks, increase investment in education, modernize infrastructure and add charging stations for electric vehicles.

“We can do all of these things. This is not an either-or choice,” Walz said.

Virginia finance officials expect the nation to fall into a recession by 2023, squeezing the state’s tax revenues. Yet the state has so much extra money than Republicans Governor Glenn Youngkin recently proposed an additional $1 billion in tax cuts and $2.6 billion in spending on education, economic development, public safety, behavioral health and the environment.

“Our state government’s financial situation has never been stronger,” Youngkin said.

Referring to a large surplus, Missouri Governor Mike Parson called lawmakers into a special fall session to pass what he described as “the largest tax cut in state history.” The first step of the final $760 million tax cut will take effect in January. Still, Missouri still expects to end its 2023 fiscal year with a surplus, leaving money to potentially spend on things like teacher pay raises.

In the first five months of its fiscal year, Missouri has already earned $116 million on its investments — nearly doubling earnings from the entire previous year. But Fitzpatrick, the treasurer, advises politicians to be cautious.

“Even though we’re making a lot of money, inflation is outpacing what we’re able to earn on our money,” said Fitzpatrick, who takes office as state auditor-elect Jan. 9. He added: “We need to be careful not to commit the state to a lot of ongoing new spending.”

Pennsylvania’s treasury is expected to collect $275 million in interest this fiscal year — 13 times the average amount over the past five years. Although only a fraction of the state’s total budget, the interest revenue would be large enough to run any of the state’s cabinet agencies for an entire year, except for education, human services and corrections.

Republican Treasurer Stacy Garrity recommended that budget writers put the extra cash in reserve, pointing out that an independent tax agency expects a billion-dollar-plus deficit for the 2023-24 budget year.

“We know a fiscal cliff is looming and it is critical that the Commonwealth prepares as much as possible,” Garrity’s office said.

Some other states are also predicting leaner times.

According to a recently revised revenue forecast, Oregon expects to reap $190 million in interest during the current budget cycle — nearly double the amount that had been projected just three months earlier. The state expects a profit of 4 billion dollars this year. But state fiscal analysts also expect a mild recession in 2023 that could help turn the surplus into a $560 million budget deficit over the next two years.

“The sharp increase in interest rates this year is equivalent to taking your foot off the gas and hitting the brakes. The car will shake, skid and even fishtail,” said a report from Oregon’s Office of Economic Analysis. “The ultimate question is, will it end up in the ditch or is the driver able to pull out of it?”


Associated Press writers Steve LeBlanc in Boston; Steve Karnowski in St. Paul, Minnesota; Marc Levy in Harrisburg, Pennsylvania; Sarah Rankin in Richmond, Virginia; and Claire Rush in Portland, Oregon, contributed to this report. Rush is a staff member for the Associated Press/Report for America Statehouse News Initiative. Report for America is a nonprofit national service program that places journalists in local newsrooms to report on undercover issues.

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