Image: Gov. Arnold Schwarzenegger
Rich Pedroncelli  /  AP file
Gov. Arnold Schwarzenegger announced this week that he will call a special session of the Legislature to deal with the looming state budget crisis.
By John W. Schoen Senior producer
updated 10/30/2008 3:22:24 PM ET 2008-10-30T19:22:24

As Congress and the White House have been working to calm financial markets and minimize damage to the economy, officials in statehouses around the country have been coping with their own gathering storm. The rapidly deteriorating economy has blown gaping holes in many state budgets that can’t be closed by borrowing money.

In recent weeks, the budget shortfalls have been growing more apparent. The result is an increasingly painful set of choices involving deeper spending cuts, increased taxes or both.

Governors, mayors and other advocates have made the rounds on Capitol Hill this week, proposing ambitious plans to build roads and water and sewer projects, extend jobless benefits and help states cope with multibillion-dollar  shortfalls.

New York Gov. David Paterson, a Democrat, pressed for help in closing a projected $12.5 billion gap caused in large part by the financial industry's meltdown. He said falling tax revenues will mean harmful cuts to in health care, anti-poverty programs and other state services.

"The cruel irony is that at the time when citizens need their state governments the most, state governments are least equipped to help them because of plummeting revenues," Paterson said. "When states are hurting, our national economy suffers."

New Jersey Gov. Jon Corzine, a Democrat and former chairman of Goldman Sachs, called for a deficit-financed stimulus measure tagged at up to 2 percent of the nation's gross domestic product — or about $300 billion — with a heavy emphasis on infrastructure projects such as road construction, railway repairs and water and sewer projects.

"This time of adversity should be translated into a time of opportunity with respect to our infrastructure projects," Corzine told the House Transportation Committee. "We should not lose the opportunity to invest in our future, our children and our grandchildren's future."

But governors and other officials aren't waiting for Congress to act. Those in the deepest financial holes have scheduled emergency legislative sessions to try to close the gaps.

But state officials have limited leeway in cutting existing budgets. Unlike the federal government, most states are not permitted by law to borrow to make up for budget shortfalls.

“We haven’t even been through a political budget process yet that takes this fiscal crisis into account," said Donald Boyd, a senior fellow at the Rockefeller Institute who follows state budgets. "The last budget process was done before things were clearly getting horrible.”   

Among the hardest-hit regions are those where the housing market downturn has been most severe. Barely a month after California belatedly filled a $15 billion hole in its new budget, the state is looking at another $3 billion in red. Gov. Arnold Schwarzenegger, a Republican, has called the legislature back to Sacramento after the election to look for ways to balance the books.

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Arizona Gov. Janet Napolitano also plans to sit down with that state's legislature in emergency session after the election to try to cope with more than $1 billion in red ink on the state’s recently enacted $9.9 billion budget. That budget already included $1.9 billion in cuts when it was enacted in June. State officials are estimating they may have to cut as much as $3 billion in next year’s budget.

“The plain fact of the matter is that the national economy, from which Arizona is not immune, took a turn that really has become kind of a perfect storm of events, and nobody really predicted that,” said Napolitano, a second-term Democrat. "So you have to deal with what you have.”

Because the cost of social services like education and health care make up a big part of most state budgets, those areas are among those most vulnerable to spending cuts. Some 17 states are cutting programs to help health care for low-income families; 16 states have cut spending on K-12 and early childhood education; and 17 states have cut spending on public colleges and universities, according to the Center on Budget Policy and Priorities.

Because they are generally not allowed to run a deficit, many states typically carry a “rainy day” fund to offset the risk of a shortfall. But those funds are not expected to cover the revenue damage from the storm battering the economy and financial markets.

“They’re never large enough to offset anywhere near the kinds of declines that states suffer when the economy goes bad,” said Boyd.

States ended the 2007 fiscal year with some $69 billion in reserves — or about 11 percent of their budgets — the most ever, according to the CBPP, which tracks fiscal policy and the impact on people with lower incomes. But many have already dipped into those reserves — even before the worst of the downturn has hit. Some 27 states are already in the red by more than $12 billion, and the CBPP estimates that the cumulative budget gap for states in 2010 will hit $100 billion.

State revenues are getting hit hard on several fronts at once:

  • With job losses rising, income taxes are falling. The projected continued rise in unemployment will cut further into state revenues.
  • The collapse of the financial markets hits two ways. First, it lowers revenues in states that tax investment income. Second, states whose economies are heavily reliant on the financial services industry will see taxes from those businesses dry up. Roughly a third of Delaware’s gross state product, for example, is based on the finance and insurance industries. New York state is also bracing for a big hit from the stock market collapse.
  • A sharp slowdown in consumer spending is hitting sales taxes revenues. If the economy worsens, consumer spending may slow further.
  • Lower demand for gasoline has shrunk receipts from gas taxes. Though pump prices have fallen sharply in recent weeks, it’s not clear that consumer demand for gasoline will rebound.

Job losses also are raising states' costs. The rise in layoffs has stretched state-run unemployment insurance funds, some of which are running out of money. Five states —Michigan, Indiana, New York, South Carolina and Ohio — have less than three months' worth of payments left, according to the National Employment Law Project. Further job losses put those states' funds closer to going broke.

Another eight states — New Jersey, California, Kentucky, Missouri, Wisconsin, North Carolina, Rhode Island and Arkansas — have just enough left for four to six months, according to NELP.

Some households suffering a job loss also lose health care insurance. Low- and moderate income families who lose company-provided health care are turning to state-administered Medicaid programs, which are jointly funding by the state and the federal government.

“Medicaid is certainly going to be a target because it’s so big," said Boyd. "It’s also very, very hard to cut because so much of it is for extremely sick people.”

To be sure, some states are faring relatively well because they rely on other sources of revenues besides incomes and sales taxes. States with large oil and gas resources, including Alaska, Texas and Oklahoma, have seen their revenues hold up relatively well. But the recent plunge in the price of oil may cut onto those funds as well.

For those states facing shortfalls, budget gaps will have to be closed with more spending cuts, higher taxes or a combination of both.

But tax increases are extremely unpopular, and many state officials are promising to do everything they can to avoid them, especially during an economic downturn.

In Louisiana, Gov. Bobby Jindal says the state will close its $1 billion budget shortfall with “very real budget reductions” — but no new taxes.

“Our administration will not be supporting any tax increases to close this gap,” he said last week. “Let me take that option off the table.”

(The Associated Press contributed to this report.)


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