State Budget Woes Create a Black Hole for U.S. Stimulus Funds

2011 looks to be a world of hurt for states. Unless there's a 2nd stimulus bill...
http://knowledge.wharton.upenn.edu/printer_friendly.cfm?articleid=2309

Arizona is considering putting its House and Senate buildings up for sale. Connecticut's governor proposed a $1 per-pack tax hike on cigarettes. Michigan's House Speaker suggested shifting its 400,000 public employees to a single health care plan, while another Michigander urged the reclassification of soda pop as a non-food item so it could be taxed at 6%. From California to Connecticut, the global recession has squeezed state finances, forcing many state governments to slash services, raise taxes or find unusually creative ways to close the gap. The widespread budget shortfalls -- expected to continue through at least 2011 -- threaten to put a drag on the nation's economic recovery and undermine President Obama's stimulus plan, according to Wharton faculty and other experts.

Indeed, much of the more than $230 billion that the federal government sent to the states to stimulate their economies over the next two years is instead being used to balance budgets. "The states aren't really playing the game like Obama hoped they would," says Wharton finance professor Robert Inman.

"The dire condition of many states is a direct result of the financial crisis," according to Wharton finance professor Itay Goldstein. "States depend on tax revenues, which decline in times of crisis due to rising unemployment, lower salaries, less spending, etc. Also, states depend on the credit market to smooth cash availability. [The credit] market has been in a freeze during the crisis, and this makes it more difficult to get financed. You combine these factors ... and you get difficult times for states, just like for firms and individuals."

At least 48 states either addressed or still face shortfalls totaling $163 billion in their budgets for fiscal year 2010, according to a recent report from the Center on Budget and Policy Priorities, a Washington, D.C.-based research center. A month after July 1, when the fiscal year in most states began, five states -- Arizona, Connecticut, Michigan, North Carolina and Pennsylvania -- remained deadlocked over how to balance their budgets. At least a dozen more states discovered billions in new shortfalls almost immediately after passing their budgets.

If projections are correct, the pain for most states won't end anytime soon. The National Conference of State Legislatures (NCSL), a Denver-based bipartisan organization that serves state lawmakers and their staffs, estimates that the cumulative state budget shortfall for fiscal years 2008 through 2012 could top $348.2 billion.

Cliff Diving in 2011

"Many states say they are looking at a cliff in 2011 because they know [the federal stimulus funding they will have received from the American Recovery and Reinvestment Act of 2009] will be gone, and they do not expect state revenue performance to rebound strongly enough to make up the difference," the NCSL reports in its recent State Budget Update for July 2009. "Many states are looking at a minimum of four to five consecutive years of deep fiscal problems."

The sudden global meltdown has hit a number of states particularly hard because their revenues depend on taxes that fluctuate with the economy. Although revenue structures vary widely among states, most states rely heavily on individual income taxes, sales taxes or both. Local (city and county) governments rely more heavily on property taxes, which are less prone to economic swings.

"Unlike the federal budget, state finances are directly and immediately shaped by the economy," says Robert B. Ward, director of fiscal studies at the Nelson A. Rockefeller Institute of Government in Albany, N.Y. "The federal government can borrow billions and even [as we now see] trillions of dollars to cover normal expenses. States generally cannot. The two primary sources of tax revenue for states are income and sales taxes. During the first three quarters of the last fiscal year, which ended on June 30 for most states, each of those taxes represented just over one-third of overall state tax revenue. Both taxes respond quickly to sharp ups or downs in economic activity."

The Rockefeller Institute recently reported that state tax revenues fell by 11.7% in the first quarter of 2009, the largest decline ever recorded during the 46 years that quarterly data has been kept. Revenues from personal income taxes fell 17.5%, from sales taxes 8.3% and from corporate income taxes 18.8%, the report said. Early figures for April and May show a nearly 20% drop in overall state tax collections.

With unemployment increasing, the decline of tax revenues is likely to get worse before it gets better. The Federal Reserve recently projected that today's 9.5% unemployment rate will peak at 10% in the fourth quarter and will remain at or above 9.5% for a year.

The pain of revenue shortfalls is especially acute given that most states are required by law to balance their budgets and cannot rely on deficit spending the way the federal government can. "Most states have balanced budget amendments," says Wharton professor of business and public policy Alexander Gelber. "That means any shortfall in revenue the state has must be covered by either raising taxes or cutting services."

Myopic Fiscal Planning

Problems also stem from myopic fiscal planning, says Wharton business and public policy professor Janet Rothenberg Pack. "Politicians are relatively short-term in their thinking. They want results while they're in office," she says. That means when the economy is good and tax revenues are flowing, states historically have spent the bulk of the cash on new programs instead of saving it for later emergencies. The recent housing bubble proved no exception.

"Expenditures almost always increase substantially when you have windfall revenues," Pack points out. "These temporary spurts in revenues have almost always led to expenditure increases, many of which are clearly not one-time expenditures. Then, when funds go back down ... or decrease, you have a constituency built in for new programs.... It's very, very difficult to cut back."

Today's sudden shortfall of state revenues threatens not just new pet programs but also timeworn government promises, such as state pension plans. "The long-term obligations are coming home to roost," says Wharton insurance and risk management professor Olivia S. Mitchell. Even before the recession, state pension plans were under considerable strain due to an aging government workforce, Mitchell notes. But the stock market crash sent state pension funds into a tailspin by reducing asset values by 25% to 35%. Public pension promises are now about $3 trillion underfunded, says Mitchell. That means states, just like individual investors trying to rebuild their 401(k) plans, need to set aside more money to make up losses.

"The states have been told [by the plan's actuaries] that they have to kick in more to keep their pension funds above water," Mitchell notes. "The gap this year is so big it's hard to see how we're going to fill it without a lot of political angst."

As the financial pressures increase, so do the number of creative solutions states use to get around their fiscal dilemmas. The state of Washington, for example, came up with a more palatable number for its state pension obligations by declaring state employees would probably work longer and die sooner than expected. California shaved about $1.2 billion off its payroll obligations by simply writing state worker paychecks a day later than usual, shifting the costs onto next year's books. "It's a way of getting around the balanced budget amendments," says Gelber. "It's shifting liabilities forward in time."

IOUs in California

Rest of article.

 

^Everything was fine before the stimulus bill. The real problems would be caused by another stimulus package.

 

Heavy dose of sarcasm for people not reading the lengthy article I posted. Pretty sad to see people take sides already without weighing the situation. It's like we're running for political office or something.

He was one of the early mainstream columnists to call out the housing bubble and its implications.

http://www.nytimes.com/2005/08/08/opinion/08krugman.html

When do you signup?

 

He meant a Black Monday for housing prices. Stagnation in housing prices would cause a painful pop in the sector. We had a decline instead. The hard crash in the housing sector took several months. It was more of a hiss than a pop.