New Year but No Relief for Strapped States

Jennifer Steinhauer|The New York Times

It is one of the bleakest new years that states have seen in over a decade.

On Wednesday, governors in California, Kentucky and New York kick off the season of addresses to state lawmakers as at least 36 states struggle to close budget shortfalls and also begin confronting the next fiscal year’s woes.

California Gov. Arnold Schwartzenegger

For many of the states, the new year spells the end to accounting maneuvers, one-off solutions, tax increases and service cuts that were as deep as lawmakers thought they could bear. And governors confront this situation in an election year in which dozens of their jobs are in play, and as many state legislators face their own election challenges.

“A budget gap of 5 percent or 10 percent in any given year is a tough problem,” said Corina Eckl, fiscal director at the National Conference of State Legislatures. “But we’re talking about gaps in excess of 20 percent over multiple years. The size of these gaps is staggering.”

California’s problems, including a projected budget deficit of $20 billion, are as outsized as the state itself.

In his state-of-the-state message here, Gov. Arnold Schwarzenegger, a Republican, will proclaim California close to incapable of paying for social services in the next fiscal year, which begins in July, unless the Obama administration greatly increases aid to the state. That will be just one of many bleak assessments — and far-from-slam-dunk prescriptions — that Mr. Schwarzenegger will proffer as he and nearly every other governor face another year of extraordinary fiscal distress.

High unemployment, continued reverberations from the foreclosure crisis and a severe drop in all forms of taxes have combined to leave states — which historically have lagged behind the private sector in recession recoveries by about two years — reeling.

State tax collections for the third quarter of 2009 showed a drop of 10.7 percent, the third consecutive quarter of double-digit revenue decline, according to the Rockefeller Institute, though the dip was smaller than the preceding two quarters.

State of the States

While some states are showing modest improvement, others continue to set record lows. Revenues for Michigan, one of the nation’s most fiscally challenged states, are at a 45-year low, when adjusted for inflation. Many of the states that increased spending generally during the rosier years of the last decade are paying for it now.

Oklahoma’s projected budget gap of $1.3 billion for the next fiscal year is the largest since the Depression, said Scott Meacham, the state treasurer.

“Government is subject to a bit of mission creep over time,” Mr. Meacham said. “We do things that are great to do but not maybe the core mission of government. We need to look at some more fundamental shifts.”

Further, the federal stimulus dollars that helped keep many local governments afloat last year will begin to evaporate. Debt service — a Peter-Paul system for many states last year — has also grown. The cost of keeping citizens in government programs, like Medicaid, has also risen, as unemployment funds have teetered toward insolvency over the last 18 months.

Cost savings so far have included cuts to specific programs; Michigan and California both stopped offering dental services to some Medicaid recipients last year. But there have also been layoffs — Kentucky’s state work force has shrunk by 1,600 over the last two years — and symbolic moves, like Delaware’s decision last year to turn state-office thermostats down in the winter and up in the summer.

In many ways, states averted deeper cuts than anticipated last year because of the federal stimulus package. But those dollars will shrink over the next fiscal year, and unless jobs return and tax revenues rise, or Congress sends them more aid, states will most likely continue to be overextended.

“We are still cash positive,” said Ann Visalli, the director of Office of Management and Budget for Delaware, where two auto plants and a major oil refinery closed this year. “However, because of the drop-off in federal stimulus and state revenues not materializing, we do have to continue with budget cuts.”

Some governors will almost certainly be looking to the federal government for help. While proclaiming that the state is not seeking a bailout, according to a draft part of his speech on Wednesday, Mr. Schwarzenegger will say, “We need to work with the feds so that we can fix the flawed formula that demands that states spend money they do not have.”

Some states will most likely continue with across-the-board cuts, accounting moves like moving last payroll dates into the next fiscal year, as California has done in the past, and furloughs. But more states are expected to face an equally unpopular choice between eliminating services or raising taxes.

Last year nine states raised income taxes, and 15 states and the District of Columbia raised taxes on cigarettes.

“There is pressure for more tax increases in more states,” said Joseph Henchman, the director of state projects for the Tax Foundation, a research group. “It will be a hard sell in states where people think spending hasn’t been cut enough.”

One test of voter tolerance for new taxes will come next month in Oregon, where voters will be asked to consider two measures that would increase taxes on corporations and wealthy taxpayers to help balance the state’s budget, specifically for education, health care and public safety.

“This will be an indication on whether or not people are willing to invest in core areas of government right now,” said Jim Ross, a political consultant who has run Democratic campaigns in Oregon. “It is true in Oregon and most other places in the country.”

There are some signs of sunshine, and opportunity, in the budget problems. Over the past three months, coincident indexes — measures of current economic conditions in a state boiled down to a single statistic — have increased in 20 states, according to the Federal Reserve Bank of Philadelphia, even as they decreased in 25 and remained unchanged in five. Unemployment has slowed in many states as well.

Further, states have had no trouble tapping the bond market; 2010 is expected to be a record year for municipal bonds, $450 billion compared with $409 billion in 2009. That is an indication that there remains investor interest and a willingness among state leaders to continue to invest in infrastructure, which can preserve or even create jobs.

States have also been forced to rethink how they do business, with examples like energy savings, new approaches to the management of prisons or the ways they manage gambling. Kentucky, for instance, wants video lottery terminals at race tracks.

“The good news is that there’s a target-rich environment for any states interested in new ideas,” said Robert B. Ward, the director of Fiscal Studies at the Rockefeller Institute, which is based in Albany.