The Inflation Revenue Dividend

State and local governments have never had so much dough.

WSJ editorial.

"One irony of inflation is that while it’s bad for working Americans, it’s great for the government. Tax revenues soar as nominal profits and incomes rise, and for evidence simply look at the boom in state and local government coffers. They’ve rarely had it so good, but don’t expect them to be frugal spenders.

Overall state and local government receipts including federal aid were 23% above pre-pandemic levels in the third quarter through September thanks to Congress’s gusher of spending and the strong economic recovery, according to the Committee for a Responsible Federal Budget.

Property, corporate, sales and individual tax revenue from the third quarter of 2020 through the second quarter of this year is running 18.3% above the same period two years ago, according to Census Bureau data. How many Americans have seen their incomes rise that much over the last two years?

Individual tax revenue has swelled thanks to frothy equity markets as the affluent realize capital gains and inflation pushes them into higher tax brackets. Sales tax revenue has also surged thanks to federal transfer payments that have boosted spending as well as corporate profits—which in turn have inflated corporate tax revenue. Buoyant housing prices are increasing property tax revenue that finances schools. 

Progressive states with higher tax rates are especially flush. State and local tax revenue in New York—which raised taxes on high earners this spring—is running $13.3 billion (21.3%) higher for the current fiscal year that began in April over the same period in 2019. Mind you, 2019 was a very good year for state coffers. (See nearby table.)

California continues to report record monthly tax collections even after Gov. Gavin Newsom boasted this spring of a $75 billion budget surplus. State tax revenue for the fiscal year starting in July through October is running nearly 25% over budget estimates and 33% more than in 2019.

These rich states have also received plenty of welfare from Washington. Congress has given states and local governments $885 billion in direct aid through the various Covid bills for schools, public transit, Medicaid and more. Now they’re set to get another large helping from the infrastructure deal for public transit, broadband, water systems and electric grids.

If the Democrats’ $4 trillion spending bill passes, they’ll get even more. By our count, about $700 billion in the Democrats’ new spending bill would go to the states for programs such as child care, universal pre-K, home healthcare and housing. Senate Majority Leader Chuck Schumer demanded $65 billion for public housing—63% more than President Biden proposed this spring—so there would be enough money to bail out the wildly mismanaged New York City Housing Authority.

Remember when the states pleaded poverty last year? We told you they didn’t need the money, and the current data proves it. States could now be using this windfall to cut taxes, and some are, but most are spending it on new commitments that won’t vanish when the revenue boom does. Democratic states in particular are building in new structural spending in the form of higher pay and pensions for public unions. Also popular are climate-change boondoggles like New York’s “green energy transmission superhighway.”

The $4 trillion Democratic entitlement bill will put states on the hook for new liabilities once the federal largesse dries up. In 2025 the feds will pay 95.4% of pre-K costs, but only 63.6% in 2027. Republican governors would be wise to opt out of the programs as many did with ObamaCare’s Medicaid expansion.

But taxpayers in conservative states like West Virginia and Arizona will still end up subsidizing expanded welfare states in the likes of California and New York. Better to call the whole thing off."