Cuts to federal aid and a recession are coming, risking a state fiscal crisis. The counterplan exacerbates this, need to save revenue now.

Some state policymakers have overreacted to the possibility of new revenue by proposing major income tax rate cuts, even cuts whose cost would exceed the highly uncertain estimate of new revenue. For instance, Idaho Governor Butch Otter proposed personal and corporate income tax rate cuts and other cuts totaling about $200 million annually after the state projected that revenues would rise by nearly $100 million due to the federal changes.8

Given the substantial uncertainty around the ultimate revenue impact, states should respond cautiously. They also should be prudent because new threats to their fiscal stability loom, including the potential for cuts in federal aid for states and localities and the inevitability of another recession.

In addition, many states lack sufficient revenues to make the new investments in people and infrastructure required for an economy in which prosperity is broadly shared. At least 30 states closed budget shortfalls this year or last year, the most since the aftermath of the Great Recession.9 States may need to raise new revenue to improve the productivity of their workforces, encourage entrepreneurship, and strengthen the physical infrastructure that undergirds private enterprise. At the least, states should avoid cutting income tax rates, which would further enrich the highestincome households even as — in most states with the biggest revenue gains — the added revenue will come disproportionately from low- and modest-income families.

Build Up Reserves to Prepare for Potential Federal Cuts and for Next Recession States would be prudent to save at least a substantial share of the revenues they receive. Many already struggle to meet their current needs, and significant new threats loom, including: •Potential cuts in federal aid to states and localities. Republican congressional leaders and the President have made clear their interest in cutting federal support for Medicaid and other federal funding for services and programs delivered by states and localities. The budget resolution that Congress passed in October 2017, which jumpstarted the tax legislation, called for $5.8 trillion in budget cuts over the next decade, with large cuts in Medicaid, Medicare, SNAP (formerly food stamps), and non-defense discretionary (NDD) funding, the part of the federal budget that includes funding for a wide range of state and local services, including K12 education, environmental protection, affordable housing, and child care.10 It’s now unlikely that significant NDD cuts will occur in the 2018 election year, or perhaps in 2019 either. But the longer-term trend in federal NDD funding is downward, both in inflation-adopted dollars and as a share of the economy. This trend is likely to continue, given both the new tax law’s shrinkage in federal tax revenue and the rising health care and retirement costs associated with the aging of the population.

The next recession. While a recession does not appear imminent, the current expansion is the second longest in American history, and in a few months will be the longest. Given this and the impossibility of predicting when the next recession will hit, states would be wise to prepare for it. The typical state ended the last fiscal year with a balance of 8 percent of the budget, less than states had heading into the last recession and far less than they need in a typical recession. The average state would require reserves of at least 15 percent of its annual budget to weather a moderate recession without significant spending cuts or tax increases; only seven states ended last year with reserves of that size.