State and local governments have limited options when faced with economic downturns that reduce tax revenues. They typically are forced to cut spending or raise taxes immediately, often exacerbating the effects of economic slowdown. Moreover, a number of state programs have federally mandated spending levels, meaning that a narrow pool of programs—and often those that serve low-income households—will suffer the brunt of budget cuts.
A self-financing tax-base insurance program would assist states and localities suffering from such revenue losses. The policies would cover a predetermined percent of state tax revenue loss in exchange for a premium equal to a flat proportion of total state tax revenues. The program would include measures to prevent misguided incentives that might encourage states to cut taxes to trigger insurance disbursements.
Local governments that are constrained to balance their budgets have been forced to deal with short-term revenue shocks by cutting spending or increasing taxes. These actions exacerbate rather than alleviate the effects of the shocks, posing a risk of long-term problems. Federal government policies to help local governments deal with such problems have been unreliable and poorly targeted. This study proposes an affordable federal instrument that could mitigate the adverse impact of tax-revenue shocks on communities by allowing them to buy tax-base insurance. With annual premiums of less than 1 percent of their tax revenues, local communities could use insurance to mitigate revenue shocks by taking advantage of risk-sharing opportunities. The strength of a tax-base insurance program is that it would predetermine eligibility, causes, and the value of compensation. It would also be dependable because it would establish a property right that communities would have already paid for.