US in dire straits with budget deficits in 43 states

The financial crisis, which has manifested itself through the collapse of banks and jobs cuts by organisations, is now finding expression in a new medium - US state budget deficits. According to the latest report issued by the Center on Budget and Policy Priorities yesterday, as many as 43 American states are facing shortfalls in their budgets for this and/or next year. Most state budgets start on July 1, which means they are nearly halfway through their fiscal year.

The Center on Budget and Policy Priorities is an American organisation that works on the state and federal level on policy research and analysis. According to the report, over half the states had already cut spending, used reserves, or raised revenues in order to adopt a balanced budget for the current fiscal year. Now, their budgets have fallen out of balance again. New gaps have opened up in the budgets of at least 37 states plus the District of Columbia after they struggled to close the largest budget shortfalls seen since the recession of 2001. And these problems are expected to continue into next year.

Current estimates are that mid-year gaps total $31.2 billion - 7.2 per cent of these states' budgets - but they will almost certainly widen as the continuing economic turmoil causes revenues to come in below estimates in more states.

The 37 states facing mid-year fiscal year 2009 shortfalls are Alabama, Arizona, California, Colorado, Connecticut, Delaware, Florida, Georgia, Hawaii, Idaho, Illinois, Kansas, Kentucky, Maine, Maryland, Massachusetts, Minnesota, Mississippi, Missouri, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Carolina, Ohio, Oregon, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Utah, Vermont, Virginia, Washington, and Wisconsin.

Those states with budgetary problems added to the shortfalls they inherited from the previous fiscal year. At the end of the last fiscal year, 29 states had shortfalls topping $48 billion. The budgetary shortfalls that states face in the current fiscal year are likely to plague states in the coming budgetary year, the report concludes.

And 28 states have already projected that they will be unable to eliminate the gap in their budgets in fiscal year 2010. For the 21 states that have already put a dollar estimate on their budgetary gap, fiscal year 2010 could have a budgetary shortfall of more than $60 billion. Considering that the current downturn is worse than the last recession, the report estimates that nearly all states will face shortfalls, and has even placed a figure of the total - $100 billion by 2010.

With unemployment rates that have already surpassed levels from the last recession, states will collect fewer income taxes and be drawn on to provide increased services to residents. And with consumers' reduced access to sources of home equity loans, the report expects states to collect less income tax.

As states attempt to get their budgets in line for the new fiscal year, the report says that budget constraints are causing 25 states to reduce services to their residences. So far 17 states have already made cuts or are considering cuts to programs that affect low-income children's and family's access to health insurance and health care services. They have also been slashing government payrolls, with at least 20 states having proposed or implemented cuts to their state workforce.

If revenue declines persist as expected in many states, additional budget cuts are likely. Budget cuts often are more severe in the second year of a state fiscal crisis, after reserves have been largely depleted and thus are no longer an option for closing deficits. The experience of the last recession is instructive as to what kinds of actions states may take.

Between 2002 and 2004 states reduced services significantly. For example, in the last recession, some 34 states cut eligibility for public health programs, causing well over 1 million people to lose health coverage, and at least 23 states cut eligibility for child care subsidies or otherwise limited access to child care. In addition, 34 states cut real per-pupil aid to school districts for K-12 education between 2002 and 2004, resulting in higher fees for textbooks and courses, shorter school days, fewer personnel, and reduced transportation.

Expenditure cuts and tax increases are problematic policies during an economic downturn because they reduce overall demand and can make the downturn deeper. When states cut spending, they lay off employees, cancel contracts with vendors, eliminate or lower payments to businesses and nonprofit organizations that provide direct services, and cut benefit payments to individuals.

In all of these circumstances, the companies and organizations that would have received government payments have less money to spend on salaries and supplies, and individuals who would have received salaries or benefits have less money for consumption. This directly removes demand from the economy. Tax increases also remove demand from the economy by reducing the amount of money people have to spend.

Federal assistance can lessen the extent to which states take pro-cyclical actions that can further harm the economy. In the recession in the early part of this decade, the federal government provided $20 billion in fiscal relief in a package enacted in 2003. There were two types of assistance to states: 1) a temporary increase in the federal share of the Medicaid program; and 2) general grants to states, based on population. Each part was for $10 billion.

The increased Medicaid match averted even deeper cuts in public health insurance than actually occurred, while the general grants helped prevent cuts in a wide variety of other critical services. The major problem with that assistance was that it was enacted many months after the beginning of the recession, so it was less effective than it could have been in preventing state actions that deepened the economic downturn.

The federal government should consider aiding states earlier, rather than waiting until the downturn is nearly over. Moreover, it seems increasingly likely that this recession will be more severe than the last recession, and thus state fiscal problems may be worse.

For instance, unemployment, which peaked after the last recession at 6.3 percent, has already hit 6.7 percent, and many economists expect it to rise much further, which will reduce state income taxes and increase demand for Medicaid and other services. And with consumers' reduced access to home equity loans and other sources of credit, sales taxes are also likely to fall more steeply than they did in the last recession. These factors suggest that a new round of fiscal relief should be larger than was enacted in 2003.