EDITORIAL: States weathering the financial storm

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What's in store for American taxpayers? Who are the best stewards of the coffers as the economic picture turns gloomier?

State budgets are facing declines in tax revenues in fiscal 2009 and 2010, and most of the lost revenue is a result of the "housing bust." Belt tightening and budget cuts are in order, but many statehouses are concerned about how the economic downturn will affect their bottom line for such capital-improvement projects as schools, mass transit, roads and bridges and other infrastructure.

States were flush with cash in March 2006, as 42 state governments recorded surpluses from more efficient collections and increased tax revenues from the housing boom, which generated higher property taxes, real-estate sales taxes and deed recordation fees. States also were borrowing 30 percent less than they did in 2005.

In August 2008, however, states discovered that revenues dropped sharply, and 29 closed a combined $48 billion in deficits, according to a report by the Center on Budget and Policy Priorities. As many as 15 states opened fiscal 2009, which began Oct. 1, knowing they would face deficits in six months. Among the 15 are states run by Republican governors - Georgia $1.6 billion, Florida $1.7 billion, South Carolina $140 million - and Democratic governors - Arizona $100 million, the District $131 million, Maryland $269 million, New York $630 million. Their total projected shortfall is $5.9 billion by March.

"States typically can't borrow to cover operating costs like the federal government can, but they can borrow for capital projects, new buildings and infrastructure improvements," said Nick Johnson director of the state fiscal project for the center. He said, at this point it is unlikely that states will face a significant problem floating bonds to investors and banks (usually the surest investment there is in the marketplace). "But some states have postponed the sale of bonds for a couple weeks," Mr. Johnson said.

Many governors were supportive of Treasury Secretary Henry Paulson's bailout for the financial markets, to free up the credit markets allowing them to borrow to keep capital improvement projects moving forward or face draining them to cover operating expenses.

California Gov. Arnold Schwarzenegger said in an Oct. 3 letter to Mr. Paulson: "Many states and local governments have been unable to secure financing for bond offerings and for routine cash flow used to make critical payments to schools, local governments and law enforcement."

Big energy states, like Alaska and Louisiana and Texas, can always depend on oil royalties to bailout their budgets, but deficits are always a potential problem in large heavily populated states like California and New York.

The housing bubble was a boon to many of the states. Not only were property tax revenues booming but also sales-tax revenue from appliances, furniture and construction materials. And many states, like Wall Street investors, overplayed the boom, spending wildly instead of saving the money in rainy-day funds.

The District, once the laughing stock in the region after going bankrupt in the 1990s, rebounded after a federal takeover. Although it faces a potential $131 million gap this fiscal year, its federally mandated $250 million rainy-day fund will help. Maryland, meanwhile, faces a potential $269 million gap. But it already drained $1 billion out of its rainy-day fund in 2007 (60 percent of its total). Then Gov. Martin O'Malley raised taxes by $1.4 billion during last year's special General Assembly session. Now even Mr. O'Malley, a Democrat, concedes that spending must be restrained. Many states have begun cutting spending ineducation, health care and programs for seniors, and some have begun laying off workers.

Even well-managed states run by fiscal conservatives - Mississippi, Tennessee, Minnesota, and others - are staring down potential deficits. The difference is they are in a position to ward off the damage with good old-fashion belt-tightening. For example, Mississippi Gov. Haley Barbour, a Republican, put $378 million into the state rainy-day fund this year. Tennessee Gov. Phil Bredesen, a Democrat, did the same. Mr. Bredesen also laid off 2,000 workers to stave off a deficit rather than tap the fund. "It's unclear whether we've hit the bottom of the economy's downward spiral, so the responsible approach is to change our spending now and hold on to our savings as long as we can," Mr. Bredesen said.

The enormity of the financial bailout means this and the next Congress, as well as whoever next occupies the White House, will surely face storm clouds. The governors in the Bible Belt can offer more than a few prudent pointers on how to curb government largess.