Federal Tax Cut Likely to Be Offset by Local Levies : Economy: States hiked taxes $25 billion in last two years and may boost them another $10 billion in 1992.

The Republican White House and Democratic Congress are all but certain to agree this year on some kind of tax cut designed to fight the recession by putting more spending money in the pockets of middle-class Americans.

But there’s a catch.

No matter whose plan winds up being approved, experts agree that none of the “economic growth” proposals currently under consideration appear big enough to offset the stiff tax increases that state and local governments have been adopting all across the country.

Consequently, the economic impact of the 1992 tax initiative may turn out to be like that of the Ronald Reagan Administration’s tax cuts in the early 1980s, when reductions in the federal income tax were largely negated by rising Social Security payroll taxes. That perception, in turn, could play into the volatile politics of a presidential election year.

“For an awful lot of people out there, the savings they will get from refinancing their mortgages, thanks to the Federal Reserve’s lower interest rates, will be a lot more significant than anything that Washington does on the tax side,” says Jerry Jordan, chief economist for First Interstate Bank in Los Angeles.

Faced with gaping budget deficits and declining revenues, state governments have raised taxes by a combined total of roughly $25 billion over the last two years, and experts predict they may hike them another $10 billion in 1992.

California alone accounted for about half of the $15 billion in state tax increases imposed last year, as Gov. Pete Wilson pushed through roughly $7.5 billion in new taxes and fees to address the state’s budgetary shortfall.

Although national statistics for tax increases adopted by cities and other local units of government are not available, municipalities all across the country have raised or considered raising property taxes, sales taxes and other local fees, analysts note.

It will take months of debate and deliberation before the White House and Congress come to terms on new tax cuts, but a reluctance to run up the federal deficit is expected to limit their size and scope. The growth plan currently under consideration by President Bush, for example, would provide tax reductions in the neighborhood of $10 billion a year.

As a result, many economists and other outside experts say they are convinced that increases in state and local taxes will more than offset anything the Republicans and Democrats in Washington wind up doing for the middle class this year.

“State budgets are in horrible shape right now, and there is nothing the states can do but cut spending and raise taxes. I doubt Congress can do as much to counter it,” says David Wyss, an economist with DRI-McGraw Hill, an economic forecasting firm in Lexington, Mass.

Adds Rudolph Penner, former director of the Congressional Budget Office: “Lord knows what they will end up doing in Washington once they get going into a bidding war on taxes, but what you see at the federal level will probably not be as much” as the state and local increases.

State and local taxes seemed relatively insignificant to many Americans until the last decade, when states began to face an array of new demands on their resources. Now, however, these levies are really starting to bite.

In many states, the increases have taken the form of gradual increases in excise taxes and fees, including such things as tuition at state universities. Nonetheless, they are now eating into the income of average taxpayers.

A 1% increase in a state’s sales tax, for instance, can take $300 away from a family that spends $30,000 a year on taxable purchases. In California, last year’s tax increases will cost each person roughly $250, or an estimated $1,000 for a family of four. The $2.9 billion in new sales taxes imposed by the state will cost roughly $96 per person.

The Bush Administration has not yet unveiled its final economic growth package, so it is difficult to calculate exactly how much the White House tax cut proposals would be worth to the average American. But some of the anti-recessionary plans now before Congress would cut taxes by as little as $300 per year, which economists say would do almost nothing to boost consumer spending in the face of rising state tax bills.

What’s more, economists note that the 1990 budget agreement between the White House and Congress raised taxes by about $30 billion. That means that for many Americans, this year’s federal tax cuts will simply wash out the federal tax hikes that hit them a year ago, with little left over to offset higher state and local levies.

Unlike Washington, many states and cities have balanced budget laws that can force them to cut spending or raise taxes during recessions, exactly the opposite of the kind of stimulative, pump-priming policies called for by traditional Keynesian economics. In earlier recessions, state and city tax hikes and spending cuts were not a serious problem for the economy because their budget woes were not as severe as they are today.

But states are in far worse shape during this slump, largely because the recession followed a golden era of soaring state revenues--and spending. During the economic boom of the 1980s, many states, especially in the Northeast, enjoyed double-digit revenue growth without raising taxes. The bumper tax collections let them vastly expand their spending programs as well.

State tax revenues began to plunge almost as soon as the current recession began, and many states found themselves facing massive deficits. New York, for instance, enjoyed 80% revenue growth between 1981 and 1988, 33% above the rate of inflation. But the state now faces a $4-billion deficit for fiscal 1993, and Gov. Mario M. Cuomo cited the state’s budget crisis as the key factor in his decision not to run for the Democratic presidential nomination.

Budget crises now dominate politics in almost every state. In Connecticut, thousands of protesters turned out earlier this winter to protest independent Gov. Lowell P. Weicker Jr.’s imposition of an income tax for the first time in the state’s history. In New Jersey, Democratic Gov. James J. Florio’s controversial tax and budget plans, which effectively socked the middle class and the affluent to help the poor, led outraged voters to rout the Democrats in last November’s elections and turn over control of the state Legislature to the Republicans.

“The poll ratings of some of these governors make Bush’s poll numbers look good,” says Stephen Moore, a budget specialist at the Cato Institute, a conservative Washington think tank.

Political observers believe that the backlash against state tax increases will prompt most governors and state legislators to try to balance their budgets this year by cutting spending rather than by raising taxes further.

“I think this will be a big year for spending cutbacks,” notes Hal Hovey, editor of State Budget and Tax News of Alexandria, Va.

Still, in many states, the recession has gotten so bad that earlier tax hikes have not closed the budget deficits. California officials, for example, are estimating that the state still faces a budget gap of $4 billion to $8 billion, despite last year’s tax increases and spending cuts. Additional spending reductions may not be enough to plug the budget hole, and more tax increases may be pushed through, analysts believe.

While many governors and other state politicians blame their budget woes on reductions in federal aid imposed during the Reagan and Bush administrations, state budget experts charge that most state officials have only themselves to blame.

“No more than 20% of the problem is due to cost-shifting from the federal government,” argues Marsha Howard, deputy director of the National Assn. of State Budget Officers. “It is the most overrated reason given by governors.”

Instead, Howard argues, states failed to save much of the revenue windfall they gained in the 1980s, and used it to expand or create new programs that now face elimination.

One big squeeze has come from soaring medical costs paid by states, which share the costs of Medicaid benefits with the federal government. Nationally, the state portion of Medicaid costs rose by $20 billion between fiscal 1990 and 1992. Medicaid now accounts for 14% of all state spending, up from just 7% in 1980.

Meanwhile, many cities are facing big problems as states try to shift some of their budget burden by slashing state-funded local aid packages. That puts even more pressure on cities to raise property taxes or other levies.

In addition, cities are more dependent on federal aid than the states, and federal revenue sharing funds for cities have dried up. In fact, federal funds as a percent of city budgets fell 64% between 1980 and 1990, at the same time that new federal and state laws and court rulings imposed new costs on cities, according to the U.S. Conference of Mayors.

Boston Mayor Raymond L. Flynn told the Senate Budget Committee earlier this month that his city’s problems reflected a “triple whammy of federal withdrawal, state cutbacks and our continuing national recession.”

Democratic leaders in Congress are beginning to recognize that state and local budget woes have become a drag on the economy, and some are forging new stimulative proposals targeted at helping local governments.

Last Thursday, Senate Majority Leader George J. Mitchell (D-Me.) called for a $100-billion cut in defense spending over the next five years, with at least part of the savings earmarked for helping state and local governments.

Mitchell said a onetime grant of an unspecified size could be used for state and local governments to help pay for police, health care services, public works and assistance in meeting new federal mandates, such as environmental and transportation regulations. The plan would not only help ease local budget problems, but also stimulate the economy by allowing states and cities to begin new spending projects and create jobs.

Such federal aid is exactly what the states and cities are screaming for.