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Tax-Refund Ruling Clouds Fiscal Outlook for Some States

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Up to 16 states may face new budgetary pressures as a result of a U.S. Supreme Court decision ordering refunds of state income taxes imposed on the pensions of retired federal workers.

The High Court ruled last month in Harper v. Virginia Department of Taxation (Case No. 91-794) that states must implement retroactively a 1989 decision declaring that it was unconstitutional to tax federal retirees' benefits while exempting those of retired state employees.

State officials and federal retirees say they are uncertain how the issue will be resolved, since the Court's opinion failed to recommend any solution. Instead, the Justices referred the case to the Virginia Supreme Court to decide a remedy.

Officials in Virginia face the most pressing and costly dilemma, as 200,000 federal pensioners stand to receive more than $470 million from the state. Among other states, the amount ranges from $339 million in Arizona to $20 million in Alabama, Montana, and Oklahoma.

For all of the states, the refunds will be a one-time expense. Since the 1989 decision, states have ended the differential treatment, either by eliminating the tax exemptions for state retirees or by extending them to federal retirees.

The refunds involved in the Harper case stem from funds Virginia collected prior to the 1989 ruling.

Observers say it is not clear whether states will respond by continuing to litigate the issue in state courts or by offering settlements to retirees.

Compensation could range from a full refund to tax credits, according to Pete Forgione, the state-legislative coordinator for the National Association of Retired Federal Employees. "States are finally admitting that they did something wrong, and we expect them to be upfront in providing some relief,'' he said.

Besides Virginia, where Gov. L. Douglas Wilder has said he wants to find a solution before his term expires in January, the court's ruling should also speed decisions in six other state cases that were connected to the Virginia appeal: Arkansas, Georgia, Montana, New York, North Carolina, and South Carolina.

Complicating the Fiscal Picture

Education officials monitoring state budgets said that while the refund issue on its own does not threaten to impose on school funds, it complicates the fiscal picture in states with other problems.

"In some states it's a lot of money and in other states it's not, but what you've got is people wanting money from states that don't have any,'' said Chris Zimmerman, the chief economist for the National Conference of State Legislatures.

In Virginia, for example, the $470 million coincides with a $700 million revenue shortfall projected for the next biennium. In Montana, where the refund case involves only about $20 million, it comes at a time when voters have put a $72 million income-tax increase on the ballot for recall.

"If it was just $20 million we wouldn't be so worried,'' said Bruce W. Moerer, the general counsel for the Montana School Boards Association. "But taken with everything else, we've got severe budget problems.''

School officials in Virginia said they are waiting to get some cue about the state's strategy before moving on the issue.

"Right now, this is something the Governor and General Assembly have to grapple with,'' said Vincent Cibbarelli, the executive director of the Virginia Association of School Superintendents.

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