As U.S. governors deliver their proposed budgets for their respective states this month, the hard work of closing widening deficits has begun in earnest. From crumbling roadways to overcrowded prisons, the impact of these budget crises is beginning to emerge. And even as state officials struggle to gauge just how deep this year’s deficit will be, some are already projecting even wider spending gaps next year.
THE LOOMING financial meltdown of state budgets was a major issue on the campaign trail last fall. This month, as newly elected officials find themselves eye-shade deep in the harsh reality of balancing the books, the dire impact of shaky state budgets is already being felt.
“This is a moment of crisis,” said Illinois’ new governor, Rod Blagojevich, when he took office last week and announced that the state’s budget deficit had swelled to nearly $5 billion.
Nebraska Gov. Mike Johanns told legislators last week that the “free-fall in tax receipts is worse than the farm crisis of the 1980s.”
In some states, the budget deficit is so large and has grown so quickly that state officials can’t agree on just how big it is. California Gov. Gray Davis has said the state treasury will come up $34.6 billion short in 2003-2004. A separate analysis by the state legislature found last week that number about $3 billion too high.
From Maine to Alaska, budget officials are wrestling with what has become a kind of perfect economic storm as several fiscal forces collide. First, many are suffering the hangover from a spending binge that accompanied the boom of the late 1990s. That boom, which generated an income tax windfall on stock market gains, stock options and bonuses, has been followed by a sharp drop in tax revenues brought about by downturns in both the stock market and the economy. At the same time, rising health care costs and increasing claims for unemployment benefits have required more spending. Now, some states with budgets stretched to the breaking point have seen their credit ratings slashed, which raises their borrowing costs. Both the National Governors Association and the National Association of State Budget Officers have called it the worst budget mess since World War II.
Unlike their federal counterparts, most state legislators are barred by law from simply borrowing money to make up budget deficits. That means the gap has to be closed every year — no matter what.
The urgency of deep state cutbacks is already being felt. On Friday, Kentucky prison officials released 328 inmates before their full sentences had been served, after Gov. Paul Patton said the state couldn’t afford to keep them in jail for their full terms. Four other states have already released inmates to save money, and others are considering similar moves.
Some states have found temporarily solutions by postponing the purchase of new equipment or dipping into “rainy day” funds. But with little evidence of another economic boom or bull market on the horizon, state officials are now turning to more permanent fixes.
“The story you have to make up to grow yourself out of this budget problem is pretty far-fetched,” said Neil Bergsman, Maryland’s budget director.
SQUEEZED CITIES
The trickle-down economics of the state money squeeze is hitting county and city budgets too. To close a $320 million budget gap, San Francisco officials are considering closing swimming pools and fire stations, jacking up parking fines, postponing pothole repairs on city streets — even raising cable car fares by 50 percent. New York City’s projected $3 billion budget shortfall, for the fiscal year that begins in July, is bigger than all but four state deficits. New York Mayor Michael Bloomberg has proposed spending cuts and higher taxes, including a controversial tax on commuters who work but don’t live in the city.
Even tax-averse Californians will almost certainly see their taxes rise. Earlier this month, Gov. Davis proposed raising $8.2 billion by boosting the state sales taxes and raising taxes on high-income residents. Republicans have vowed not to approve any tax increases.
But finding ways to cut back won’t be easy. While state spending rose steadily through the 1990s, much of that spending was determined by the federal government — especially in the area of health care benefits. Spending on Medicaid, the federally-mandated, state-funded health program, is now the second-largest piece of the state budget pie, after education, according to Scott Pattison, executive director of the National Association of State Budget Officers.
”(States are) taking on more and more things that Medicare would otherwise cover,” he said. “A huge expense now for states is elderly people in nursing homes. That’s way beyond what was envisioned for Medicaid.”
The rapid rise in spending on basic services like health care has left state legislatures with little room to maneuver, according to Robert Kurttner, who is monitoring the state budget meltdown as a credit analyst at Moody’s Investor Service.
“It’s difficult when you’ve extended healthcare benefits to working poor people, to pregnant women and children, to categories of disabled people,” he said. “It’s very difficult politically to take benefits away from a truly needy group.”
But state legislators may have no other choice. California lawmakers began hearings last week on a plan to cut more than $10 billion in spending, including big cuts in health care programs.
Where tax increases appear unavoidable, “sin” taxes have become a politically popular stopgap. Georgia Gov. Sonny Purdue, the state’s first Republican governor in more than a century, last week said he wants to cover nearly two-thirds of the state’s budget shortfall with higher taxes on beer and cigarettes — which he says will also help cut down on smoking-related health care costs. Missouri Gov. Bob Holden wants to boost cigarette taxes even though voters rejected a similar measure on November’s ballot. Holden also wants to raise taxes and fees on riverboat gambling.
Nineteen states have already boosted taxes on cigarettes and alcohol, generating nearly $3 billion in new funds, according to a November survey of the National Association of State Budget Officers. But those revenues won’t begin to close the gap in many states.
Tobacco is helping close the budget gap in another way: Some states are paying their bills by diverting money from a landmark 1998 legal settlement originally intended to fund anti-smoking campaigns. (To settle state lawsuits, tobacco companies agreed to pay $206 billion over 25 years to 46 states; four others settled separately for a total of $40 billion.) In some cases, states are selling bonds backed by future settlement payments to cover next year’s spending. But by borrowing against future payments, states will give up a portion of those revenues.
While some states are raising taxes on gambling, others are looking to expand their own slot machine winnings. Maryland’s new Republican governor, Robert L. Ehrlich, Jr., wants to generate $800 million a year with a network of video slot machines. Other states are considering similar moves.
BLEAK OUTLOOK
This month’s flurry of debate over spending proposals brings state officials a step closer to closing their budget gaps — for now. But without federal relief or a rapid economic turnaround, the prospects are not bright. Some states that are already making projections for next year see the budget gap widening.
A lot depends on how quickly the economy recovers. But even if a strong recovery began today, states wouldn’t see income tax receipts pick up until next April.
“There’s a fair amount of lag time,” said Pattison. “It could be as much as a year to 18 months” before states felt the effect of a strong national economic recovery.
Ironically, the Bush administration’s plan to get the national economy moving again will be flying into a stiff headwind of deep cuts in state spending — which together make up roughly 10 percent of the $10 trillion U.S. gross domestic product.
“The states are going to be neutralizing any fiscal stimulus that occurs,” said Susan Herring, an economist at UBS Warburg.
State officials further point out that the Bush administration’s recent tax cut plan, as proposed, would pour gasoline on the financial fire. Cutting taxes on dividends would hurt two ways. First, it would eliminate yet another source of tax revenues, because the 43 states that tax personal income calculate those taxes based on federal taxable income. So they have no way of maintaining dividend taxes even if they wanted to.
But cutting dividend taxes could also reduce demand for another major source of state funding — municipal bonds. If investors no longer favor tax-free bonds over dividend-paying stocks, state and local borrowing costs could rise.
California’s treasurer, Phil Angelides, claims the Bush tax plan would cost California taxpayers $17 billion over the next 10 years in higher interest cost on bonds and “shakes the very foundation of our road to economic recovery.”
The Associated Press and Reuters contributed to this report.