Recession's End Marks Start Of States' Budget Woes

The recession is probably over, which means states' financial troubles have only begun.

History suggests it could take six or more years for sales and income taxes _ which make up roughly two-thirds of states' revenue _ to return to pre-recession levels. That could lead to deeper cuts to state jobs and services in order to maintain funding for core programs such as public schools and Medicaid.

What's different from the three previous recessions, which took states three to five years to recover from, is that employment and consumer spending aren't expected to bounce back as quickly.

To balance their budgets in the meantime, states are likely to raise taxes on the money people earn and spend; increase college tuition; reduce funding for the arts and other cultural programs; and push costs into the future by delaying pay raises for employees and repairs of government buildings. Some states, including Massachusetts, Missouri and Arizona, already are making or considering fresh cuts just months after lawmakers agreed on new budgets.

Rising unemployment and a decline in consumer spending have put a big dent in states' tax revenues. Census figures show states' income taxes plunged almost 28 percent in the second quarter of 2009, falling even further in places such as Arizona and California that were among the hardest hit by the housing market collapse. States' quarterly sales taxes fell almost 10 percent compared to the previous year.

Unlike the federal government, states generally must balance their budgets. That's why one-third of states have raised taxes this year. They've hit the wealthy with income tax surcharges, hiked sales taxes that disproportionately affect the poor and targeted smokers, drinkers and motorists with higher taxes and fees.

Hundreds of thousands of state employees have been furloughed. And government "rainy day" funds have been diminished to half their highs of just three years ago.

Billions of dollars in federal stimulus money has enabled state lawmakers to maintain funding for programs like Medicaid and public schools. But that emergency aid will run out long before the labor market improves and states' budgets have healed. At that point, further cuts to less vital services are a near certainty.

"Even though this national recovery will happen, state revenues are still going to be facing some pretty horrific times," says Sujit CanagaRetna, a senior fiscal analyst for the Council of State Governments.

After the recession that began in July 1981 it took three years before states' revenues fully rebounded, adjusting for inflation, population growth and tax increases, says Donald Boyd, a senior fellow at the Rockefeller Institute of Government at the State University of New York in Albany. He says it took states between four and five years to recover from the recessions that began in July 1990 and March 2001.

Based on that analysis, "I wouldn't be surprised for it to take (states) six or seven years to get back to where they were" before this recession began in December 2007, he says. "What certainly is going to have to happen is several rounds of significant tax increases and, or, spending cuts."

State lawmakers responded to the early 1980s recession with three consecutive years of higher taxes that, when compounded, amounted to a nearly 11 percent hike over the pre-recession tax levels, Boyd said. The early 1990s recession resulted in a similar three-year tax pattern that affected virtually all economic classes by raising levies on individual and corporate incomes, retail sales and motor fuel.

Part of the reason for the prolonged recovery is that states are starting from a deep financial hole. They face a combined budget gap for 2010-2011 of more than $350 billion and, in some states, next year's shortfall is expected to exceed one-quarter of their general fund budgets, according to the Center on Budget and Policy Priorities.
Another reason why most states can expect a slow rebound is that personal income taxes account for more than one-third of revenues, on average, in the 41 states that levy them, according to the National Association of State Budget Officers.

Following the recession of the early 2000s, the national unemployment rate peaked at 6.3 percent. It now stands at 9.8 percent, but is above 10 percent in a dozen states. The last time the nationwide unemployment rate surpassed 10 percent was after the recession that began in 1981.

Federal Reserve Chairman Ben Bernanke says the recession is "very likely over," but that unemployment is likely to get worse before it gets better. Some economists say it could take at least four years for the jobless rate to drop down to a more normal range of 5 percent.

While sales taxes typically rebound more quickly than income taxes, that is not necessarily going to happen this time around. Retail sales have fallen further this recession than in any other during the past four decades, according to Boyd's research. That's because jobs remain scarce, credit has tightened and home prices are down, instilling a frugality that appears to have staying power.

In anticipation of a slow budgetary recovery, some states are seeking to push costs into the future.

In Rhode Island, a proposal to avoid a government shutdown would require state employees to work 12 days without pay over the next two years. In return, they would get extra vacation days and could receive pay for some of their lost wages _ but not until they retire or leave their jobs.

In Minnesota, Gov. Tim Pawlenty is balancing the budget by delaying nearly $1.8 billion of payments to schools until after the end of the current school year. The state's action has created a ripple effect for school districts, which are tapping reserves and borrowing money to pay staff, food and utility bills.

Complicating the recovery is the fact that some state services have barely rebounded from the last recession.

Funding for Missouri's public colleges and universities, for example, peaked at just under $950 million in the 2001 fiscal year before getting sliced the following two years. State higher education aid didn't inch past the 2001 level until 2009. But core funding for Missouri's public colleges and universities now has been frozen indefinitely because of the recession.

Told that any requested funding increases would require equal cuts from elsewhere its budget, the Missouri Coordinating Board for Higher Education last month recommended yet another flat year of funding for 2011.

The result is that Missouri's colleges and universities would get about the same amount of money as they did a decade ago, despite rising operating costs and enrollments that the state board says have grown as the recession prompts more people to seek new job training.

"The economy might improve, but the state's budget is still going to have some serious problems," says Paul Wagner, Missouri's deputy higher education commissioner.