States’ New Budget Battle

After years of cost-cutting and staring down deficits, states suddenly find themselves awash in extra dollars that are funding tax cuts, teacher pay increases and roadwork across the country.

Only four states have had to deal with deficits as legislatures rush to finalize budgets before the end of the fiscal year on June 30. The rest are enjoying surpluses that have fueled a 4.2% growth in state government spending, the biggest surge since 1999.

Kentucky gave teachers 10% raises, Utah founded an institute for science research, and Florida bought a 71,000-acre ranch to be set aside as open space. North Carolina plans to spend more on mental-health care. Many states like California, which has not adopted its budget yet, are paying down debt used to balance the books during the recession at the start of the decade.

There’s so much excess money that some states like Arizona have argued over how big of a tax cut to grant residents. A recent survey of state budgets found that $1.4 billion in income-tax cuts have been proposed nationwide.

“States are enjoying the best fiscal situation they’ve seen in five years,” said Arturo Perez, an analyst with the National Conference of State Legislatures in Denver.

But state financial officials aren’t celebrating yet. Much of the new money comes not from higher wages of taxpayers, but from less sustainable sources, such as the super-heated housing market, skyrocketing corporate income taxes or taxes on investment gains earned by richer citizens.

“The good news on revenue has been generated from a very narrow base,” Perez said.

That parallels the mixed record of the national economy, which grew at a robust 5.3% in the first three months of this year. Corporations are enjoying record profits, but the stock market has struggled to top 11,000, dropping sharply last week. And the value of the average worker’s paycheck is being slowly eroded by inflation.

Because of anxieties about these dynamics -- and memories of the massive deficits of a few years ago -- state financial officials are being cautious with their newfound wealth.

“The economy is going to have its ups and downs,” said George Cunningham, deputy chief of staff to Arizona Gov. Janet Napolitano. The Democratic governor fought with a Republican Legislature over whether to grant a $500-million tax cut before reaching a compromise that legislators finalized early Saturday. The tax reduction will now occur over two years, and Napolitano will be able to launch some new spending, including repairing cuts to state universities.

“Next time we go down,” Cunningham said, “we don’t want to be in the toilet like we were last time.”

Fiscal officers in other states are nervous about the future of the economy, said Scott D. Pattison, executive officer of the National Assn. of State Budget Officers, which conducted the survey of state budgets with the National Governors Assn. “They’re saying, ‘I see it’s sunny and blue skies out there when I look out the window, but my projections show it pretty rainy and stormy soon.”

Even without a downturn, many states project that their revenues will start declining next year. The National Conference of State Legislatures says 19 states, including Iowa, Maryland and California, see a deficit reopening in the next two years because they routinely spend more than they take in.

California’s revenues are up $7.5 billion over what budget experts had projected. The windfall was enough to wipe out the deficit for the coming budget year, but multibillion-dollar deficits are projected to return next year as the real estate market cools.

That has prompted Republican Gov. Arnold Schwarzenegger and lawmakers to take a conservative approach. They plan to use a big chunk of the money to pay down state debt early and restore billions of dollars borrowed from schools to balance prior years’ budgets. Even so, there are signs that lawmakers may target some money for pet programs -- including tax breaks for corporations and an expansion of health insurance programs for low-income children.

Several legislatures have chosen to spend money on one-time costs, such as repairing roads or patching up government buildings. North Carolina, which is still finalizing its budget, plans to dedicate $200 million from its $1- billion surplus to roadwork. It also proposes to double the size of its reserve fund, to $620 million.

The state wants to take on a few recurring costs, such as an 8% raise for teachers. Agencies that suffered during the downturn from 2000 to 2004 also would receive more funds. Mental-health services, which operated on such spare budgets that state contractors sometimes were not paid for treating patients, are expecting a 16% increase in funds this year.

“We’ve been starving,” said Flo Stein, an official at the state department of Health and Human Services. “Everything came together in North Carolina this year.”

Some states have debated how much to cut taxes. Florida Republican Gov. Jeb Bush proposed $1.5 billion in cuts, but legislators agreed to only $300 million, stashing much of the extra money in reserve accounts. Florida also spent cash on items like the purchase of Babcock Ranch as part of a state conservation project.

Some Utah legislators pushed for a $231-million rebate to citizens. But the governor and a majority in the Legislature instead chose to spend $300 million of the $1.1-billion surplus on road repairs and a 6% raise for teachers. The state also funded a science research center to attract more technology businesses. In the end, the state spent $90 million cutting sales and corporate taxes and held onto $70 million so it could work out an income-tax cut next year.

In Oregon, Democratic Gov. Ted Kulongoski is trying to work around a budget requirement that state revenues that exceed projections by more than 2% be refunded to taxpayers.

Oregon’s sizzling housing market is a key reason the state may be forced to hand out $1 billion in refunds. Republicans say the money must be returned, but Kulongoski wants to suspend the refunds to restore some of the deep cuts of recent years.

Arizona has been transfixed for weeks by the budget showdown between Napolitano, a centrist up for reelection this fall, and an increasingly hard-line Republican Legislature. She has already vetoed a record number of bills and had threatened to derail the budget if the Legislature insisted on its tax cut.

With the hottest real estate market in the nation in 2005, Arizona dedicated a $1-billion surplus to transportation and building projects, as well as lawsuit settlements and other one-time needs. The battle was over an extra $500 million.

Napolitano had proposed $100 million in tax reductions, earmarking the rest for a variety of purposes, including extended kindergarten classes, raises for prison guards and extra funding for public universities.

She said a broad tax cut would be financially irresponsible.

Legislators were called back from vacation last week to be ready to pass a budget, but negotiations between the leaders of each chamber and Napolitano dragged on for three days. On Friday afternoon, Napolitano agreed to the Legislature’s tax cut. It will be spread over two years, however, as will the governor’s extra education spending. The compromise budget passed the House late Friday night and cleared the Senate on Saturday. Napolitano is expected to sign it.

State Rep. Stephen W. Tully, chairman of the Arizona House of Representatives appropriations committee, said legislators believed the boom times allowed the state to increase education spending and trim taxes. “They’re not mutually exclusive,” he said.

Pattison, of the National Assn. of State Budget Officers, said the Arizona debate showed all sides were acting responsibly.

“They’ve been burned before,” Pattison said, “and are really cautious.”

Times staff writer Evan Halper in Sacramento contributed to this report.