Policy Points: Updated June 29, 2009
Policy Points: New Fiscal Year Brings Continued Trouble for States Due to Economic Downturn
Federal Economic Recovery Funds Providing Some Relief
The weak economy continues to cause great fiscal distress among states as they begin a new fiscal year (July 1 marks the start of 2010 for most states). Combined budget gaps for the remainder of the current fiscal year and the next two years are estimated to total more than $350 billion.
The American Recovery and Reinvestment Act includes roughly $140 billion in fiscal relief for state governments, enough to close 30-40 percent of state shortfalls. States are using these funds to help balance their budgets while minimizing harmful cuts in public services.
Although the recovery package is mitigating states’ fiscal problems, states are continuing to cut services like education and health care as they enact 2010 budgets. To date at least 39 states have addressed their shortfalls by reducing services to their residents, including some of their most vulnerable families and individuals. Cuts to state services not only harm vulnerable residents but also worsen the recession by reducing overall economic activity.
Twenty-five states have enacted tax increases this year in response to budget shortfalls caused by the recession, and another 12 are considering them.. Like budget cuts, tax increases remove demand from the economy, by reducing the amount of money people have to spend. But tax increases can be better for state economies than budget cuts because some of the tax increases result in reduced saving rather than reduced consumption.
Forty-eight states faced or are facing budget shortfalls.
- At least 48 states addressed or are facing shortfalls in their budgets for the upcoming year totaling $166 billion or 24 percent of state budgets. This includes $23 billion in shortfalls that have opened in 12 states in just the few weeks since they passed their 2010 budgets. All of those states had already taken major steps to balance their budgets and the new gaps will require further action during the year to restore balance.
- At least 29 states have prepared estimates for the 2011 fiscal year. Initial estimates of these shortfalls total almost $38 billion. As the full extent of 2011 deficits become known, shortfalls are likely to equal $160 to $180 billion.
- These shortfalls come on top of $111 billion in 2009 gaps that states closed through a combination of spending cuts, withdrawals from reserves, revenue increases, or use of federal stimulus dollars.
Combined budget gaps for the remainder of this fiscal year and state fiscal years 2010 and 2011 are estimated to total over $350 billion.
States are using fiscal relief to balance their budgets.
- The $787 billion American Recovery and Reinvestment Act (ARRA) included approximately $135 billion to $140 billion for states to maintain current programs, which are being squeezed between rising demand for services and sharply declining tax revenues. The federal aid is enough to close, on average, roughly 30-40 percent of state budget shortfalls.
- These ARRA dollars closed 31 percent of New York’s budget gap and 37 percent of Virginia’s. Other states, such as Georgia, Maryland, Utah, Washington, and West Virginia report similar outcomes. States are closing the remaining gaps with a mix of spending cuts, revenue increases, withdrawals from reserve funds, and other measures.
- Despite these changes, most or all of these states are making other cuts in their budgets, which the federal legislation will be insufficient to reverse.
At least 39 states have cut a range of services, including those aimed at some of their most vulnerable residents. Also, 25 states have raised taxes and another 12 are considering similar measures
- At least 21 states have enacted or implemented cuts that will affect low-income families’ eligibility for health insurance or reduce their access to health care; at least 22 states and Washington, D.C. are cutting medical, rehabilitative, home care, or other services needed by low-income people who are elderly or have disabilities; at least 24 states are cutting K-12 and early education; and at least 32 states have implemented cuts to public colleges and universities. Also, at least 40 states and Washington, D.C. have proposed or implemented cuts to their state workforce.
- At least 25 states already have enacted tax increases, closed loopholes, restricted tax credits, increased tobacco taxes, raised tuitions, or implemented other revenue-raising measures.
The state revenue situation is rapidly worsening.
- To keep pace with the cost of services, state revenues must grow. But overall revenues last year were essentially flat and have weakened dramatically this year. The Rockefeller Institute of Government reports state tax collections fell 12.6 percent in the first quarter of 2009 compared with last year.
- Sales taxes are the largest source of state tax revenue, and they are declining due to the fall in both personal consumption and business purchases. Income taxes and other taxes are also falling as wages and investment income decline. According to the Rockefeller Institute of Government, income tax collections during the first four months of this year fell by 26 percent compared to the same period last year. Continued job losses will depress revenues further.
States face other problems from the weakening economy.
- Employers are reducing jobs and cutting back on employer-provided health coverage. As a result, more families are turning to programs like Medicaid, which provides health coverage to low- and moderate-income families and is jointly funded by Washington and the states.
- State spending levels were relatively low even before this crisis. Aggregate state spending fell sharply relative to the economy during the 2001 recession, and it remained below the 2001 level as a share of the economy when states adopted their 2008 budgets. The funding cuts that states will likely make in the coming months will reduce overall spending further below 2001 levels.
- States have already substantially used budget reserves to address funding gaps, but these reserves are limited. States ended fiscal 2006 and 2007 with $69 billion in reserves each year, equal to about 11 percent of their budgets. Those are the largest reserves states have ever accumulated. But now states have used a significant portion of those reserves, and the remaining amount will not be enough to solve state budget problems.
