Grim News for State Budgets

Many states are greeting 2008 with a major budget hangover and are looking for relief from falling home sales, higher energy prices and reduced sales-tax collections after two years of overflowing coffers.

Red ink was showing up in as many as 20 state ledgers as the year began, and if the country dips into a recession, the number of states projecting deficits would certainly grow. “Clearly, it’s a little more gloomy than it was once was,” Raymond C. Scheppach, executive director of the National Governors Association, said.

The stalled housing market is hurting states across the board, but it’s more severe for states such as Arizona, California, Nevada and Florida that rely heavily on real-estate taxes. A drop in home sales and prices mean states get a smaller cut – of sales taxes as well as real-estate-related levies – because most people who buy homes also purchase new appliances and carpeting and spend big money on home improvements.

Florida is particularly dependent on sales-tax revenue because it does not have a state income tax. The booming housing market had also filled state coffers in another way. With interest rates low, many homeowners refinanced, tapping into their homes for easy equity and then splurging on renovations or major purchases. Sales taxes on these big-ticket items brought in a significant chunk of change.

While personal income taxes are the largest single source of state tax revenue, revenue from sales taxes is more closely watched because its fluctuations are considered an early indicator of the health of the U.S. economy. As 2007 ended, 19 states told the National Conference of State Legislatures that overall sales-tax collections were failing to keep pace with what forecasters had projected for early 2008, signaling that states may face budget shortfalls.

California is struggling to plug a projected $14 billion deficit for 2008-2009, while Florida is looking at a $2.5 billion estimated gap between spending and revenue. Other states facing shortfalls include Maine, Michigan, New York and Virginia.

Part of the problem, some critics say, is states need to be more realistic in their budget projections and watch their spending more closely. “Budget woes have a lot to do with economic forecasts. Were prior economic forecasts a little too rosy?” Chris Edwards, director of tax policy at Cato, a libertarian think tank, asked.

Unlike the federal government, which can run a deficit, every state except Vermont has a legal requirement to balance its budget. That means if tax revenues fall short of what a state had projected, then it either has to cut programs or find other sources of revenue. The fiscal year begins July 1 for all but four states: Alabama, Michigan, New York and Texas.

All this grim news comes at a time when national job growth is sluggish and consumer confidence is at a nearly two-year low. Eighteen states said they are “concerned” about their revenue outlook – triple the number of last year, according to NCSL.

Like a shopper who just finished a spending spree and noticed less money in the bank, states foresee some belttightening. State spending is expected to grow 4.7 percent in fiscal 2008, NGA predicted. That’s far below the robust 9.3 percent growth states saw in fiscal 2007 and even lower than the 30-year average of 6.4 percent.

States in 2008 also will have less money in their reserves than in the previous two years. After three years of bulging rainy day funds, state balances collectively are projected to fall to $51 billion in this fiscal year, compared to nearly $67 billion the year before and a record $81 billion in fiscal 2006, according to NCSL.

“We’ve seen the peak in state balances,” said Corina Eckl, NCSL’s director of fiscal affairs, concluding that “state finances are in transition” and heading downward. States are worried about the amount of money coming in because they plan big-ticket programs in 2008. Health care, transportation and education rank as the top three priorities for states in the coming legislative year. Other looming costs are health care and pension benefits for retiring state workers, estimated to total $2.73 trillion over the next 30 years, and states are $731 billion short, according to the Pew Center on the States.

The biggest component of a state health care budget is Medicaid, the state-federal health care program that covers 59 million disabled or low-income children and adults. It is budgeted to grow 8 percent.

Scott D. Pattison, executive director of the National Association of State Budget Officers, described the states’ revenue picture this way: “States’ fiscal health was so strong in the ’06-’07 period that they could have had no problem running the Marine Corps Marathon, but now we are starting to see some sluggish growth. … I think states can do a walkrun of a 10K, but not necessarily at the peak that they could run a marathon.”