State Finances: Budget Pressures Will Crimp Spending

Hard times for state governments will slow the economic recovery nationwide.

By Richard Sammon, Senior Associate Editor, The Kiplinger Letter

June 16, 2008

Many states are about to go into belt-tightening mode, cutting spending and searching for new revenue to deal with a bleak budget outlook that's likely to last two to three years. Half the states are grappling with shortfalls, and most of the remaining states have little room to maneuver financially. The combined shortfall is $16 billion this year, with a projected $32 billion in the next fiscal year, which for states starts July 1.

State budgets are being hurt by the soft economy, which brings down individual and corporate income tax receipts, consumer confidence and purchasing. They're also grappling with rising energy and health care costs, the subprime mortgage fallout, declining home sales and home construction and larger social welfare spending.

The state problem will make the national economy worse because states are big spenders. Their outlays total about $1.8 trillion a year, or about 13% of gross domestic product. Over the past few years, they have kept spending high and fueled regional growth, drawing on rainy-day funds and other slight changes in targeted revenue raising policies to comply with laws requiring balanced budgets.

But that's changing, and tighter spending plans and tax changes will be a weight on a national economic recovery. Plus looming on the horizon is a major state worker pension and retiree health care crisis, with governors and lawmakers having to scramble to shore up underfunded accounts as more aging state workers retire.

The gaps between revenue and spending and the need to balance books will spur heavier competition for resources for outsourced contract work, such as for accounting services and park maintenance, surface transportation contracts, car and truck maintenance, school construction and repairs, building construction and inspection and, in some cases, funds for state-run and privately run prisons.

Hardest hit next year: California, which will account for fully half of the national shortfall. Look for Sacramento to boost the sales tax from 6% to 7%, suspend several tax deductions available to businesses and tap hundreds of millions of dollars set aside for public transit.

Arizona, Florida, Hawaii, Michigan, New Jersey and Nevada also face lean times. New Jersey will cut its workforce and probably reduce property tax rebates. Michigan will close 20 state parks, putting concessionaires out of business, hike various licensing fees and cancel scientific research programs. Hawaii will delay work on a large backlog of school repair projects. Nevada will brace for across-the-board budget cuts, with an exemption for K-12 education.

Other states will also lay off workers, limit aid to local communities, slash budgets for state colleges and delay or nix road and bridge work. And expect states to increasingly lean on private-public partnerships to save money on everything from accounting services to road maintenance.

Few states will follow California in raising taxes in an election year. New York, for example, defeated a proposal to increase taxes on millionaires. And earlier proposals in many states to begin imposing sales taxes on more service industry companies are going nowhere. Still, several states will look at raising some targeted taxes, such as on alcohol and tobacco. Massachusetts is considering an additional $1 per pack sales tax on cigarettes, but the legislature will nix less popular ideas for across-the-board sales tax increases.

There are some bright spots: Texas, Arkansas, Kansas, Nebraska and Oklahoma -- with their wealth of agriculture and energy production -- are thriving. Oklahoma will spend $100 million next year to refurbish its schools. Arkansas' severance tax on natural gas production in the state will help keep its budget in the black.

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