NEW YORK, Aug 24: Should a set of additional federal tax cuts recently proposed by President George W. Bush gain traction, the effect could cause state finances to deteriorate further, analysts said on Friday.

As the economic rebound falters, US states have grappled with daunting deficits by cutting spending and seeking additional revenue sources, mostly by raising taxes. Unlike the federal government which can run deficits indefinitely, states are required to balance their budgets yearly.

In a forum on the economy in Waco, Texas last week, Bush said he would consider a new round of tax cuts which would allow taxpayers to increase the amount of stock market losses an individual can claim. Among other measures, he also advocated cutting taxes on capital gains income and dividends.

But experts say because many states derive much of their revenue from capital gains taxes, their ability to navigate through economic weakness would be thrown off course by a tax reduction on assets.

There are things that the federal government is doing that will have a negative pass-through effect on the states, and will reduce revenue further, said Frank Mauro, executive director at the Fiscal Policy Institute in New York.

The tumult in global equity markets, created by the weakening economy and myriad corporate accounting scandals, has eroded the finances of the federal government, as well as of states. As a result, the Bush administration has sought ways to restore investor confidence and stabilize stock markets.

But analysts have greeted the proposal — which comes on top of last year’s $1.3 trillion tax relief package with more than a little skepticism, criticizing it as a reflexive measure that could worsen the government’s finances and put states in a lurch.

Iris Lav, deputy director of the Center for Budget and Policy Priorities in Washington, D.C., estimates that at least 36 states would suffer a reduction in state revenue if a new capital loss provision becomes law.

Lav explained that some state tax codes automatically conform to current tax law for recording capital gains and losses. She saw as unlikely the idea states would willingly “decouple” their tax provisions from those of the federal government.

This revenue reduction would come at a time when many states have already cut spending and raised taxes to close deficits of approximately $44 billion for their 2002 fiscal year, she said.

Because virtually all states must balance their budgets, new federal tax cuts that flow through to state revenues ... will force states to make additional budget cuts, or raise additional taxes, Lav added.

Some observers say the federal government’s fiscal flexibility should lead it to spend more on state aid which would keep governors from raising taxes and unwittingly stifling economic growth further rather than a new tax cut.

What the federal government can do is to preclude that drag on the economy by providing fiscal relief to US states, said the Fiscal Policy Institute’s Mauro. —Reuters