- The Washington Times - Monday, August 31, 2009

No sooner had state lawmakers around the country gone home after spending months plugging ever-widening budget gaps for fiscal 2010 than signs of new trouble began to emerge.

After finally closing the books on budgets that began July 1, many legislatures must now call members back to square spending with revenues that can’t seem to keep up.

“The unprecedented state fiscal problems brought on by the worst decline in tax receipts in decades show no sign of letting up,” said Elizabeth McNichol, a senior fellow at the Center on Budget and Policy Priorities (CBPP), a liberal-leaning think tank.

“The current recession is more severe — deeper and longer — than the last one, and state fiscal problems have proven to be worse and are likely to remain so,” she said.

Gov. Tim Kaine, Virginia Democrat, recently reported a $1.5 billion revenue shortfall, which he said will have to be bridged by budget cuts and possible layoffs of state employees in fiscal 2010. “I can’t say anything is off the table,” Mr. Kaine said Aug. 19 after addressing legislative leaders on the state’s financial situation.

Maryland Gov. Martin O’Malley outlined $454 million in budget cuts on Tuesday to erase a deficit in the budget year that began July 1. The cuts would include laying off more than 200 state workers, imposing furloughs on other state employees, reducing state aid to local governments by $211 million and cutting higher-education spending by $36 million.

Fiscal 2010 and 2011 look especially bleak because state revenue streams, which were terrible last year, are now collapsing at unprecedented rates. Even if the national economy begins growing during the second half of this year, most economists expect today’s unemployment rate of 9.4 percent to approach or exceed 10 percent and remain near that level for most of 2010. That will raise demand for state-provided social services, such as Medicaid, and reduce revenues from sales and income taxes.

According to the National Conference on State Legislatures, states had to eliminate nearly $75 billion in deficits during fiscal 2009 while simultaneously confronting almost $150 billion in additional deficits projected for fiscal 2010. Unlike the federal government, nearly all states must balance their budgets on a yearly basis.

For fiscal 2010, 48 states faced budget shortfalls that totaled $165 billion, or 24 percent of projected spending, estimates the CBPP. Only North Dakota and Montana escaped the task of eliminating deficits.

Most states addressed these shortfalls through a combination of budget cuts, tax increases, rainy-day fund drawdowns and proceeds from the federal government’s $787 billion economic stimulus package.

By all accounts, California was the big loser, forced to close a $26 billion deficit for fiscal 2010. After raising its sales tax and personal income tax earlier this year, California cut 2010 spending in July by $15 billion and borrowed billions more from local governments.

“It’s not an easy budget. It’s a tough budget. But it’s a necessary budget,” Gov. Arnold Schwarzenegger said.

Forced to issue IOUs earlier this year, California held a garage sale last weekend, hoping to sell nearly 600 state-owned vehicles and thousands of pieces of office furniture. Other state clutter being sold on eBay and Craigslist included prison uniforms, jewelry, pianos and an Xbox 360 game system. The state expected to raise hundreds of thousands of dollars.

California isn’t alone in cutting spending.

A state-by-state survey conducted by the CBPP found that at least 21 states cut public health care programs, 22 states curtailed services to the elderly and the disabled, 24 states enacted cuts in primary and secondary education and 32 states cut funding or raised tuition (or both) in higher education.

More than half the states slashed spending on prisons.

In health care, California and Michigan eliminated dental and vision services for many Medicaid recipients.

Florida relaxed nursing-home staffing requirements, and Nevada increased the qualifying standards for nursing-home care.

Arizona, Florida and South Carolina all reduced per-pupil funding by about $100, and Massachusetts cut spending for several early-care programs.

College tuition is spiking in numerous states, including Florida, where all 11 public universities raised tuition by 15 percent this year.

Government employment, which steadily increased throughout much of the recession, will also face the state budget ax in the current fiscal year. Ohio plans to eliminate as many as 2,700 positions, or 4.5 percent of the state work force. Beginning earlier this year, California state workers have been required to take several unpaid furlough days each month.

Tax increases have also figured prominently in efforts to close state budget holes for the fiscal year that began July 1.

So far, according to the CBPP, 30 states have enacted tax increases since January, and several more are considering doing so. At least 11 states raised personal income taxes, 12 have lifted state sales taxes, 11 have increased business taxes and 18 states raised taxes on tobacco or alcohol. Motor vehicle fees and taxes jumped in at least 12 states.

California, which faced a two-year deficit of more than $40 billion in the winter, increased its income tax by 0.25 percentage point and raised its state sales tax 1 percentage point to 8.25 percent. That brought the combined state and local sales tax to 9.75 percent in Los Angeles County and above 10 percent in other areas of the state.

Facing a 29 percent gap in its fiscal 2010 budget, New York increased its income tax from 6.85 percent to 8.97 percent for households with taxable income above $500,000 and extended the range of services covered by its sales tax.

Three states — Hawaii, Oregon and New Jersey — joined California by jumping into double-digit income-tax-rate territory.

“So-called ‘millionaire taxes’ on high-income people are politically safe targets for politicians to tap in a recession,” said Kail Padgitt, a staff economist at the Tax Foundation, a nonpartisan tax-research group. “The problem with these kinds of taxes, as evidenced by California, is that soaring revenues in good economic times encourage excessive spending, which leads to an inevitable budget shortfall during downturns.”

The Tax Foundation noted that California’s general-fund spending increased 31 percent to $99 billion between 2003 and 2007, despite the fact that inflation totaled only 12 percent and population growth was just 5 percent.

“States shouldn’t assume that revenue surges in good times will continue indefinitely, and the more reliant a state is on high-income earners, the bigger hit that state will sustain when those revenue surges eventually end,” said Mark Robyn of the Tax Foundation.

Besides California’s Mr. Schwarzenegger, Republican governors in other states have bucked the party’s opposition to raising taxes, including Florida Gov. Charlie Crist, who is running for the U.S. Senate. Mississippi Gov. Haley Barbour, a former tobacco lobbyist and former chairman of the Republican National Committee, increased the state cigarette tax by 50 cents a pack.

To close their 2009 and 2010 budget gaps, most states relied extensively on funds from the $787 billion economic-stimulus package, officially known as the American Recovery and Reinvestment Act (ARRA), which was enacted in February. ARRA will provide about $135 billion to state operating funds for their 2009-2011 fiscal years, enough to close as much as 40 percent of projected deficits during that period.

The biggest ARRA funding stream to the states comes from an estimated $87 billion earmarked for Medicaid, the joint federal-state program to fund health care for the poor. The $48 billion State Fiscal Stabilization Fund includes $39.5 billion to forestall additional cuts in education spending and a flexible block grant of $8.8 billion to fund general government services.

States also relied on their rainy-day funds to close their 2009 and 2010 budget gaps. As a result, those depleted coffers will have less money available for 2011 and beyond.

Already, 34 states have looked ahead to fiscal 2011. So far, projected deficits for 2011 total $67 billion, according to a CBPP tally. But those numbers are expected to rise significantly, just as deficit projections for 2009 and 2010 continuously rose.

Consider the trend for fiscal 2009, which began July 1, 2008. “The $31.8 billion gap that states reported in November 2008 grew to $47.4 billion in January 2009,” according to the latest State Budget Update issued by the National Conference of State Legislatures. “The amount rose to $62.4 billion by April and ultimately reached $73 billion before the fiscal year ended.”

CBPP estimates the states’ cumulative 2011 budget gap will reach $180 billion, deeper than this year’s hole, which is expanding again.

Already, California, whose unemployment rate is 11.9 percent and rising, is projecting a $15 billion deficit in 2011. Other states that have projected 2011 deficits include Illinois ($10.4 billion), New Jersey ($6 billion), Florida ($5 billion), New York ($4.6 billion), Connecticut and North Carolina ($4.4 billion) and Oregon ($4.2 billion).

Barely two weeks into the new fiscal year, the Rockefeller Institute of Government reported that the longest, deepest recession since the Great Depression continued to decimate state tax revenues, all but guaranteeing that governors and state legislatures would have to revisit their 2010 budgets. Even worse were indications that looming state budget deficits for fiscal 2011 would be bigger than this year’s.

Taxes collected by the 50 states plunged by nearly 12 percent during the first quarter of 2009 compared to year-earlier levels, the Rockefeller institute reported last month.

It was the biggest decline in the 46 years that quarterly data have been available. Tax revenues in the first quarter were falling nearly three times faster than they declined in the fourth quarter.

Preliminary data for April and May indicated that tax collections were much worse than during the first three months of the year.

State revenues plummeted across the board during the January-March period. Compared to the first quarter of 2008, state personal income tax receipts were down an unprecedented 17.5 percent as 36 states reported declines.

Corporate income taxes flowing into state coffers were 18.8 percent below year-earlier levels.

Revenues from sales taxes were down 8.3 percent in the first quarter, much worse than the decline in sales tax revenue during the previous recession.

For April and May, total tax collections appeared to be nearly 20 percent below last year’s levels.

“Such extraordinary weakness in revenues, along with continued, if more moderate, growth in expenditures, make widespread budget shortfalls highly likely this year,” the Rockefeller report declared.

Given their requirement to be balanced, state budgets face huge challenges whenever the economy weakens and unemployment rises.

“Unfortunately, when revenue growth declines as a result of a weakened economy, spending pressures for social programs and health care increase,” the National Association of State Budget Officers explained in its latest Fiscal Survey of States. “State fiscal conditions historically lag behind any national economic recovery, which indicates that state fiscal conditions will remain weak in fiscal 2010 and likely into fiscal years 2011 and 2012.”

Even though the last recession ended in November 2001, for example, the unemployment rate did not peak until June 2003. Then, unemployment peaked at just 6.3 percent. Today, the jobless rate is 9.4 percent and expected to rise and remain elevated for quite some time. Not only will the high unemployment rate produce lower income-tax revenues. It will also hurt consumer spending, which, in turn, will generate less revenue from sales taxes.

A vicious cycle is easy to imagine.

“Housing markets might be slow to fully recover,” said Ms. McNichol of CBPP. “Their decline has already depressed consumption and sales tax revenue as people refrain from buying furniture, appliances, construction materials and the like. This also would depress property tax revenues, increasing the likelihood that local governments will look to states to help address the squeeze on local and education budgets.”

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