Economist Arthur Laffer annually compares the economic and revenue conditions in the states, noting, “With people, products and capital free to move from state to state, state governments are competitors.” Given California’s budget difficulties it is no surprise that the Golden State ranks poorly in the new Laffer analysis.

California is not the only state that is suffering in these difficult times. The Laffer account reports that state revenues declined 8.09% from Fiscal Year (FY) 2008 to FY 2009. Heading into this Fiscal Year, 48 states faced budget shortfalls. While many states implemented measures to close their funding gaps, 41 states have come up short.

Laffer and co-author Mark A. Wise argue that, “The evidence suggests that pro-growth policies result in higher after-tax returns, increased economic activity, and an eventual improvement in overall state fiscal health; anti-growth policies result in the opposite effects.” Comparing the nine states that have no broad base income tax with the nine states that have the highest marginal income tax rate (California ranks fourth at 10.55%), the report says that, generally, states that tax less on “productive activities such as working and investing, experience higher growth rates (GSP) than states which tax more.”

It should be noted, however, that the personal income tax status does not rescue the low tax states from high unemployment rates. Three states in each of the high tax rate category and no tax rate category have double-digit unemployment. California is tied with the highest unemployment at 11.7% along with no-income tax state Nevada.

The report’s authors warned that state lawmakers’ decisions during difficult economic times hold long-term consequences to state’s fiscal health. They urged state lawmakers to see opportunity in the fiscal crisis to make reforms to inefficient tax codes. However, they concluded: “In the end, the policy debate has essentially boiled down to a choice between cutting spending, hiking taxes or some combination of the two. And when it comes to tax hikes in revenue strapped states, they undoubtedly target the usual suspects: sales taxes, sin taxes, and most popular of all, the wealthy.”

State rankings were based on 15 factors, including tax rate increases and tax burdens, workers compensation costs, debt service and the number of public employees per one-thousand residents, among other factors.

California’s Economic Outlook Rank stood at 46, falling three places from 43 in the last report.

Beyond rankings, the report took a look at a state’s solvency as measured by the state’s combined state and local debt service as a percentage of combined state and local tax revenue. Under this measure, California ranks 16th from the top at 8.7%. Despite that figure, California continues to have some of the worst bond ratings from the bond rating agencies.

The authors argued that unless serious reforms are put forth in the worst four ranked large states, New York, New Jersey, California, and Illinois, they will continue to see large budget deficits and will persistently come up short on their revenue projections.

The authors suggested remedies: “By tax reform, we mean lowering and broadening personal and corporate income taxes by flattening the tax structure and spreading the tax burden more onto the consumer. Sales taxes are a far more stable source of revenues for states than are personal income taxes. Reducing the highest marginal tax rates would immediately energize the state’s most productive individuals, which will lead to a boost to average incomes and growth as well as attract more talent from outside its borders.”