By Josh Boaks
AP Economics Writer
WASHINGTON — Income inequality is taking a toll on state governments.
The widening gap between the wealthiest Americans and everyone else has been matched by a slowdown in state tax revenue, according to a report released Monday by Standard & Poor’s.
Even as income for the affluent has accelerated, it has barely kept pace with inflation for most other people. That trend can mean a double-whammy for states: The wealthy often manage to shield much of their income from taxes and they tend to spend less of it than others do, thereby limiting sales tax revenue.
As tax revenue growth has slowed, states have faced tensions over whether to raise taxes or cut spending to balance their budgets as required by law.
“Rising income inequality is not just a social issue,” said Gabriel Petek, the S&P credit analyst who wrote the report. “It presents a very significant set of challenges for the policymakers.”
Stagnant pay for most people has compounded the pressure on states to preserve money for education, highways and social programs such as Medicaid. States’ investments in education and infrastructure have also fueled economic growth. Yet they are at risk without a strong flow of tax revenue.
The prospect of having to raise taxes to balance a state budget is a politically delicate one. The allure of low taxes has been used by states to spur job creation by attracting factories, businesses and corporate headquarters.
“If you’ve got political pressure to spend more money and pressure against raising taxes,” said David Brunori, a public policy professor at George Washington University, “then you’re in a pickle.”
Income inequality is not the only factor slowing state tax revenue. Online retailers, which account for an increasing chunk of consumer spending, often manage to avoid sales taxes. Consumers are spending more on untaxed services, too.
Some states are scrambling for new revenue sources. Pennsylvania has raised fees for vanity license plates and other auto expenses. Colorado and Washington legalized recreational marijuana, in part on the promise that the proceeds would be taxed.
According to government data adjusted for inflation, the median household income rose by a few thousand dollars since 1979 to $51,017 in 2012 and remains below its level before the recession began in late 2007. By contrast, the top 1 percent has thrived. Their incomes averaged $1.26 million in 2012, up from $466,302 in 1979, according IRS data.
Before income inequality began to rise consistently, state tax revenue grew an average of 9.97 percent a year from 1950 to 1979. That average steadily fell with each subsequent decade, dipping to 3.62 percent between 2000 and 2009.
State tax revenue growth has risen slightly since then as the economy has recovered and some states — California, Connecticut, New Jersey and New York, for example — have adopted higher top marginal income tax rates, according to S&P.
The most affluent Americans typically receive most of their income from profits in stocks and other investments, rather than wages. This means that swings in financial markets can cause state revenue to vary from year to year.
Some states — including Arizona, Florida, Nevada, Texas and Washington — rely primarily on sales taxes for money. They depend more on consumer spending and do not benefit much from the gains that have flowed mainly to the wealthiest Americans.
Across all states, sales taxes account for 30.1 percent of all state revenue, according to the National Conference of State Legislatures. Personal income taxes make up 36.6 percent. The rest comes from other sources, such as taxes on fuel, alcohol and cigarettes.
As consumers have spent more online and on untaxed services, many states have tried to tax items such as Netflix subscriptions and iTunes downloads. Washington state now taxes services at dating centers, tanning salons and Turkish baths.
Kim Rueben, a senior fellow at the Urban Institute, said the rise of untaxed purchases might have squeezed state revenue even if income inequality hadn’t widened.
Research by Lucy Dadayan, a senior policy analyst at the Nelson A. Rockefeller Institute of Government, notes that income tax collections have become more volatile from year to year, making it harder for states to plan budgets, provide services and launch programs. She said she endorses an overhaul of state tax codes to produce a more balanced revenue flow.
But according to S&P, its findings suggest that the wealth gap derives from many factors and that state tax-code revisions don’t fully address the consequences.
“Changes to state fiscal policy alone,” according to the S&P report, “won’t likely fix what’s wrong.”