US state budgets: US state and local finances have become truly alarming. At $144 billion the combined budget gap this year for the 50 states is higher than the $133 billion of the previous year. What’s more, last year’s federal stimulus funds, which helped mitigate the gap, will end by December. Since their finances are highly dependent on the economy, if the recovery slows or double-dips, states and local governments could suffer more pain than any other player save the long-term unemployed.
Much of states’ current budgetary problems result from bad decision-making. According to a Federal Reserve Bank of San Francisco study, if California and Oregon had kept per capita state expenditures and taxes constant over the past four years, both states would have had budget gaps for the current year of about 20 per cent of state spending. In practice, California continued to increase spending, while Oregon imposed substantial tax increases and restrained spending. Consequently California’s actual 2009-10 budget gap was 37 per cent of state spending while Oregon’s was 7 per cent.
Both states and localities have economically sensitive income sources. For states, sales tax yields depend directly on spending, while corporate and personal income tax yields are leveraged, falling faster than the economy in recessions. Total state income fell 11 per cent in the four quarters to June 2009, the worst drop since World War Two. Local property taxes depend largely on the housing market. State and local spending on law enforcement and education do not fall in recessions, while unemployment, Medicare and Medicaid benefits vary inversely with economic activity.
In most cycles, energetic economic recovery rescues state finances although state budgets typically lag – for example the budget gap peaked in 2004 after the 2000-01 recession. However, given their poor current position, if today’s recovery is sluggish or even “double-dips” state and local budget-makers may find it impossible to cope.
At the municipal level, bond defaults may soar well beyond 2009’s $6.4 billion - the most since 1992. State bankruptcy is technically impossible, and draconian action like Governor Chris Christie’s budget cuts in New Jersey, may postpone crisis. But if recent fears about a double-dip prove correct, it won’t be long before the first state bond default since Arkansas in 1933 rears its ugly head.