Let the Meager Times Roll; Half of States Face Shortfalls

State budgets are off the critical list, but don't put away the respirators just yet. The fiscal health of many states is still weak and in some cases anemic.

Here are a few reasons states' fiscal outlooks for 2005 are so tenuous:

  • The national economic recovery is not creating jobs, and most state budgets rely heavily on income taxes and earnings from employment. 
  • Uncle Sam probably won't come to the rescue again. Congress doled out $20 billion to help states patch gaps in fiscal 2003 and 2004. The "fiscal relief" package will run out this June 30, just as the 2005 fiscal year begins for most states. 
  • Many states used temporary or one-time fixes, such as depleting state rainy day reserves or drawing on tobacco settlement money, to balance the books in 2003 and 2004, and the holes will reappear in 2005.

A Feb. 19 report from the National Conference of State Legislatures said 31 states will have budget gaps totaling $35.6 billion for fiscal 2005, which starts this July 1 for all but four states. California's $15 billion shortfall accounts for 42 percent of the projected '05 gap. "We remain guardedly optimistic about the financial future of states," NCSL President Marty Stephens said in a statement.

A a February report from the Center on Budget and Policy Priorities found that 29 states are projecting budget shortfalls totaling up to $41 billion for fiscal 2005. The Washington, D.C., group, which studies policies that affect the poor, said "tough budget choices" loom as governors present their budget plans and lawmakers begin work on next year's budgets.

The states last year weathered a fiscal crisis that many governors called the worst since the Great Depression. "Everybody was in intensive care a year ago. This year, most are being upgraded to stable condition," said Scott D. Pattison, executive director of the National Association of State Budget Officers, known as NASBO.

Nationally, the economy has improved significantly -- productivity is up and unemployment is down but that's not enough to pull states out of a big slump, said a January 2004 report from the Rockefeller Institute of Government for the Kaiser Commission on Medicaid and the Uninsured. "States are by no means out of the woods yet," the report concluded.

California is probably the best-known example of a state flooded in red ink. Gov. Arnold Schwarzenegger (R) is banking on voters approving a bond measure in March to plug its projected $15 billion deficit for 2004-2005. Florida, Michigan, New Jersey and New York are among states that already relied on temporary fixes, such as bond issues and other one-time solutions, and now will be left with gaps in fiscal 2005, the Rockefeller report said.

Other states in trouble include Alabama, Alaska, Arizona, Kansas and Mississippi, according to the CBPP report. These states face budget shortfalls of at least 10 percent.

States in the Pacific West Coast and Great Lakes area that rely heavily on manufacturing also face lean times because the manufacturing sector has yet to turn around, NASBO's Pattison said.

The current fiscal year is "a little bit better" for most states following three years in which states collectively closed $200 billion in budget deficits, said Sujit CanagaRetna, a senior fiscal analyst with The Council of State Governments. "It's going to be grimmer next [fiscal] year" if state revenues are far off the mark, which was the case in fiscal 2003.

Last year, states collected almost $24 billion less in personal income, corporate income and sales tax revenue than they had originally budgeted, according to a December 2003 report from NASBO and the National Governors Association. "If projections aren't being met, that's a definite sign that states are in real trouble and that there might be some structural problems," Pattison of NASBO said.

States sliced programs or raised taxes to balance their books last year and now that the easiest fixes have been made, many will have to make even tougher choices for fiscal 2005. At least 15 states will consider tax proposals during their 2004 legislative sessions, NCSL reported. Several governors have pitched tax reform packages that include tax hikes:

  • In Iowa, Gov. Tom Vilsack (D) wants to boost the price of every pack of cigarettes by 60 cents and to tax more services, including engineering, surveying, accounting and consulting services.
  • Kentucky Gov. Ernie Fletcher (R) wants to raise the cigarette tax as part of a tax system overhaul that lowers the top income tax rate and expands the sales tax to certain services.
  • Virginia Gov. Mark R. Warner (D) pitched raising the sales tax by 1 cent, creating a new top income tax rate and raising the state's cigarette tax. Key Republicans in both chambers have countered with competing plans that also would raise taxes. The Senate GOP plan would hike sales, income and cigarette taxes, and a House plan would raise sales taxes on certain businesses.
  • In Michigan, Gov. Jennifer Granholm (D) proposed several tax reforms, including a 75-cents-a-pack cigarette tax increase to help plug the state's Medicaid budget gap. The move would bring Michigan's cigarette tax from $1.25 to $2 a pack, the second highest in the nation behind New Jersey, at $2.05. 
  • New York Gov. George Pataki (R) wants to put a new tax on home security systems, sporting events and amusement parks to help balance the 2005 state budget.
  • In Arkansas, Gov. Mike Huckabee (R) is letting a $377 million tax increase for education improvements become law without his signature. The state was under court order to spend more for education.

Big cuts in programs are in the offing, too, notably in Oregon, where voters in early February rejected an $800 million tax increase package. The vote is expected to trigger cuts of $299 million for schools, $58 million for public safety and $188 million from the Oregon health plan.

Alabama is another state eyeing cuts. Alabama Gov. Bob Riley's (R) budget includes $300 million in state spending cutbacks after voters last year gave the governor's tax increase proposal the thumbs down.

Many governors are optimistic that their states have turned the corner. Idaho Gov. Dirk Kempthorne (R) said, "We're on the road to recovery ... We are one more year into what is a multi-year path to recovery."

West Virginia, however, is projecting deficits for the next six years.

NASBO's Pattison said states and governors will likely face "pent-up demand" from groups that saw their projects cut and from state employees who were denied pay raises for the past two years. "It's going to be tough ... There's just no way that there will be sufficient revenue to meet anywhere near those expectations," he said.