Alabama tax collections grew at an eye-popping rate in the 2022 fiscal year, with particularly strong growth in income tax collections (up 27% over 2021) and online sales (up more than 20%). The strong collections produced surpluses in both primary state accounts: the Education Trust Fund and the General Fund.

While the growth is sparking talks of rebates and tax cuts, inflation will increase the cost of operating state government. At the same time, rising interest rates and diminishing levels of federal relief will likely slow growth going forward.

Alabama has had a string of record years when it comes to tax collections, with no discernable drag caused by the pandemic shutdown and the subsequent recovery. Preceding the pandemic, Alabama experienced historically low unemployment and was beginning to increase labor force participation rates, drawing discouraged workers off the sidelines and contributing to income gains.

While the pandemic sent a sudden jolt through the economy, federal relief kept paychecks coming for many and provided stimulus money to households as well. Alabama’s dip in the second quarter of 2020 wasn’t as sharp as some states, and the economy reopened more quickly than some. In fiscal 2021, the continued federal stimulus and the recovering job market produced record growth in tax collections. And in fiscal 2022, total collections grew even faster, 18% across both funds, with the strongest growth in the Education Trust Fund.

State revenues have climbed in recent years, even with the pandemic. (Public Affairs Research Council of Alabama)

Education Trust Fund

Income and sales tax collections rise with a growing economy and can shrink when the economy contracts and goes into recession. Inflation, which has averaged below 3% over the past 20 years, averaged over 7% during 2022. Since people spend more, sales taxes rise and tax collections also grow.

At the same time, during fiscal 2022, there was a strong demand for workers, with historically low unemployment. To attract and retain employees, employers increased wages. Alabama’s workforce returned to and exceeded pre-pandemic numbers in fiscal 2022. Alabama’s labor force participation rate is still 5% lower than the U.S. rate, but the strong job market has drawn more people back into the labor force.

During fiscal 2022, the number of people working in Alabama surpassed pre-pandemic peaks, though that didn’t occur until July.

With more workers receiving higher pay comes higher income tax collections. Income tax receipts were up 27% in fiscal 2022, contributing a total of $7.2 billion to the Education Trust Fund, up $1.5 billion from 2021. And 2021 wasn’t a down year; income tax collections increased 21% in 2021. Even in fiscal 2020, the year that included the pandemic contraction, income tax collections rose almost 7%.

Income taxes are the biggest source of education dollars. (Public Affairs Research Council of Alabama)

In addition to rising wages contributing to higher income tax receipts, Alabama corporate income tax collections were up 33% in 2022, an increase of $325 million over fiscal 2021. Another likely contributor to 2022 collections was stock market gains in 2021, a year in which the S&P 500 was up by 27%. Taxes on those gains would have flowed in during the 2022 fiscal year. Another contributing factor is the return to a normal level of auditing by the government after pandemic-related restrictions; some gains may be attributed to settlements from prior years and increased compliance.

Sales Taxes

Meanwhile, state sales tax collections were up 7.66% – nearly identical to the 7.7% rate of inflation over the period. The state makes some adjustments to the sales tax before making a final deposit in the Education Trust Fund, which slightly decreased the percentage gain to the fund. Ultimately, revenue from sales taxes flowing to the Education Trust Fund increased 6.8%, or $159 million. The use tax, a companion to the sales tax but assessed on out-of-state purchases of goods and machinery, was up 18%, contributing an additional $35 million. The state portion of the Simplified Sellers Use Tax (SSUT), a tax on online purchases, was up 21%, suggesting a continuing migration toward online shopping. Overall, the SSUT brought in $311 million, with  75% of the proceeds going to the General Fund. Overall, the Education Trust Fund grew 21%, an increase of $1.78 billion, with total collections at $10.42 billion.

Tax revenues from online purchases have soared in recent years. (Public Affairs Research Council of Alabama)

Because of the state Rolling Reserve Act, the Education Trust Fund is budgeted conservatively, with spending capped by a formula. That formula computes a historical growth rate for the fund, keeping lawmakers from overspending in periods of high growth and preserving funds for lean times. It more than did its job in fiscal 2022: The Education Trust Fund brought in $2.75 billion more than the state budgeted for education spending. Legislators will determine in next year’s session what to do with the surplus.

The massive injection of federal aid for education, which amounts to over $3 billion over three years, will be tapering off in 2024. Regardless, the state has healthy reserves and has continued to budget conservatively with state funds. The fiscal 2023 Education Trust Fund budget calls for spending $8.3 billion, $2 billion less than what was collected in fiscal 2022.

The General Fund

The General Fund also grew, but not at the same rate, which is typical. The Education Trust Fund grows fast when the economy grows, while the General Fund sees a slower growth rate. The General Fund is made up of a hodgepodge of revenue sources. It supports the operation of all the government’s non-education agencies, including Medicaid and the state prison system.

The Legislature has made several adjustments in recent years to increase growth in the General Fund. The most successful was the establishment of the Simplified Sellers Use Tax and directing 75% of the revenue on Internet sales to the General Fund. The shift toward digital commerce will continue, but revenue gains won’t likely advance as rapidly going forward.

The General Fund gets its revenue from multiple sources. (Public Affairs Research Council of Alabama)

Insurance company taxes also provided a major boost to the General Fund in 2022, up 13% or $65 million. The tax is assessed on the value of insurance premiums issued. The insurance company tax is the largest tax source in the General Fund at $554 million in fiscal 2022.

The use tax, at $272 million, was the second largest contributor to the General Fund. This is a tax on purchases of cars, machinery, boats, mobile homes or other goods in other states for use in Alabama. In 2022, revenue from the Use Tax increased by 18%, providing an additional $35 million to the General Fund than in 2021.

Rising interest rates increased revenue from the interest earned off state deposits, boosting revenue by $20 million to $40 million. Higher energy prices boosted tax revenue from oil and gas production taxes, up by 80% for an increase of $17 million.

Total growth in the General Fund increased 8.4%, a slightly higher rate than inflation. Total collections increased from $2.56 billion to $2.87 billion. By the end of 2022, receipts to the General Fund were $351 million above fiscal 2022 budgeted expenses. The Legislature anticipated the surplus and applied it to the 2023 budget.

The Big Picture

In addition to the taxes earmarked for the Education Trust Fund and the General Fund, other state revenue streams flow directly to agencies. For example, taxes on motor fuels flow to the Alabama Department of Transportation for highways. State colleges and universities collected tuition. Federal funds help pay for highways, Medicaid, education and social services. About half of Alabama’s public spending is for education and half for non-education agencies.

If a recession does cause a contraction in revenues, Alabama is in a better position to weather a downturn than in the past. According to a recent analysis by the Pew Charitable Trust, Alabama has the 20th strongest reserves, with $1.4 billion stashed away in rainy day funds. According to Pew, Alabama could run 49 days on the amount it has in reserve.

This article originally appeared on the website of the Public Affairs Research Council of Alabama.