Federal Aid Makes Up State Revenue Shortfalls

(MoneyWatch)  Due to the fact that states rely on the sales and real estate taxes to make up a large portion of their revenue the falling economy has led to a significant drop in revenues. Most states do have income taxes but they tend to be low. USA Today reports that for the first time in a great deal of time that Federal funds now make up the majority of state revenue. The article using U.S. Department of Commerce data shows the funding compared to the first quarter of 2008 as this:

• Federal grants: Increase 15%
• Income Tax: Decrease 11%
• Property Tax: Increase 2%
• Sales Tax: Decrease 2%
• Other: Increase 2%

The bulk of this is made up through the stimulus funds on top of the normal aid provided for eduction, health and human services and road construction. Many states are facing massive revenue shortfalls as tax collections are down. Of the two trillion dollars that states will spend this year about four hundred and sixty billion will come from the Feds.

The stimulus bill allowed several states to not carry out planned severe cuts to school and safety employment. In Alabama, where I live, for example the 2009 budget is twenty-nine percent bigger then last years but forty percent of it is from the stimulus bill. This is fine except in one or two years those funds won't be there. Unless the state sees a major spike in economic activity or raises taxes there will be major cuts to Alabama's spending in 2011 or so. Other states will be in this bind as well, unless the Federal government continues these large transfers into the future.

The major problem of course is that the Feds aren't exactly using their tax revenue to pay for all this. They are borrowing more-and-more and this will continue in the foreseeable future. The Obama Administration and Congress will have to either reduce spending eventually or raise taxes. This may have to happen sooner then planned if the Chinese continue to reduce their buying of U.S. bonds.

The governments of America at all levels have tried to sustain a growth in spending that ultimately is becoming unsustainable as revenue declines with the economy. At some point something will give somewhere whether it is a collapse of spending, inflation or tax increases.