The turmoil on Wall Street is setting off warning bells in state capitols. The immediate casualty is the loss of millions of dollars in the value of states' pension funds and other investments, but a bigger fear of state officials is a prolonged financial crisis that further reduces already shrinking tax revenue.
Most states diversify their portfolios, which helps cushion the collapse of the investment bank Lehman Brothers Holdings Inc. and the federal takeover of giant insurer American International Group Inc. Of greater long-term concern to state officials, they say, is how events on Wall Street are tightening credit, threatening to slow down business and consumer spending.
If that continues, state tax revenues could plunge further at a time when more than half of states already are having trouble making ends meet because of the mortgage meltdown that began last year. Because every state but Vermont is constitutionally required to balance its budget, they have little maneuvering room. So at least 29 states have instituted some combination of spending cuts, hiring freezes, tax increases and borrowing to cover shortfalls.
“The impact on tax revenue is likely to be significant and damaging,” said Robert Ward, deputy director of the Rockefeller Institute of Government in Albany.
New York, which already projects a $22 billion budget gap over the next three years, would be hardest hit because the financial services industry is the largest in the state. According to some estimates, financial workers account for 20 percent of annual state tax revenues. Connecticut and New Jersey are also braced for a hit.
Besides suffering the budgetary effects of a national financial crisis, states will also face a regulatory impact. They will be forced to oversee the unwinding of AIG assets as it complies with terms of the $85 billion federal takeover. The nation's largest insurer gradually will sell off its insurance units to repay Uncle Sam over the next two years.
Read the full report Wall Street Ills Worsen State Fiscal Headaches on Stateline.org