US States’ Credit Resilient Despite Weaker April Income Tax Revenues

As widely anticipated, state income tax revenues for April have been coming in well below the prior year, and in some cases below state projections. However, most U.S. states are still on track to meet or exceed year-end budget forecasts due to a combination of conservative revenue forecasting and continued growth in other categories of state taxes, Fitch Ratings says. Many states used prior-year revenue surpluses to improve financial resilience by boosting reserves and paying down debt, supporting state ratings stability.

As states set their budgets for fiscal 2024, most are using cautious revenue forecasts that are generally in line with Fitch’s expectation for a mild recession later in 2023. Those states implementing significant new spending plans or major tax policy changes could face additional budgetary pressure in the near and medium term, depending on the severity of revenue slowdowns.

April is a key month for states given the traditional mid-April income tax deadline. Last April’s robust performance drove very large budget surpluses for many states. This year loomed particularly large given the anticipated drop-off in tax revenues due to slower overall economic growth and weak capital markets performance in calendar year 2022, which is an indicator for capital gains income. Based on data from early reporting states, this is playing out largely as expected.

Among early-reporting states, Illinois’ legislative fiscal office reported a sharp $1.844 billion decline in April general fund revenue, 23% lower than the prior year, with personal income taxes (PIT) falling $1.5 billion (-32%). Similarly, Pennsylvania’s April PIT receipts declined 30% yoy, but growth in other taxes, including corporate income and sales taxes, limited the overall revenue drop to 13%. Total April general fund revenue in Georgia dropped 16.5% from last year, led by a 32% yoy fall in individual income taxes.

Despite April tax revenue declines, all three states are on track to comfortably exceed their adopted budget revenue forecasts, which anticipated tax revenue declines for the full fiscal year. Illinois had budgeted a 7.4% drop in tax revenue but has seen a smaller 1.0% yoy decline in year-to-date (YTD) tax revenue through April. Pennsylvania was expecting a 1.6% drop but has so far seen positive YTD growth of 2.4%.

Massachusetts also budgeted for a decline in fiscal 2023 revenues, but the actual drop in YTD revenues has been worse than expected. Through February, YTD collections were about $1 billion above the state’s original forecast. However, following a 31% yoy decline in total tax revenue in April, YTD collections are now more than $700 million below initial projections.

About 30 states, including Illinois, Georgia and Massachusetts, adopted pass-through entity taxes in the last five years, which may have had an additional negative effect on April income tax collections. Massachusetts officials estimate that April collections fell by 20% after adjusting for the effect of elective pass-through entity excise taxes. The pass-throughs are structured as a workaround to the $10,000 cap on state and local tax deductions that were included in the 2017 Tax Cuts and Jobs Act. They are intended to be revenue-neutral for states, but the complicated mix of payments, credits and refunds can take multiple years, resulting in unpredictable revenue volatility in any single year.

Almost all states with income taxes that have reported April receipts, including Alabama, Arkansas, Idaho, Iowa, Kansas, Missouri, and Montana, have seen YOY revenue declines. West Virginia is the exception, as it benefited from the first year of a newly adopted pass-through entity tax, reporting a 4% yoy increase in total April general fund revenues.
Source: Fitch Ratings