States could face historic fiscal crisis

The moribund economy is drying up tax revenues more dramatically than expected, forcing 22 states, including California, to confront growing budget gaps. Some states have already eliminated jobs and services -- and more cuts are likely.

The new shortfalls -- totaling at least $11.2 billion -- come just months after numerous states enacted belt-tightening measures while writing their yearly budgets. Officials also adjusted their revenue projections downward to account for the slowing economy. But in many cases, the actual revenue for the first quarter of the fiscal year, which began July 1, has proven to be even lower.

The gaps “will almost certainly widen” as tax revenues continue to disappoint, according to the Center on Budget and Policy Priorities, a Washington think tank that compiled the state data in a report this month.

Economists and other observers fear the numbers may signal the onset of a historic fiscal crisis for state governments.

“States have been confronted with bad economic circumstances in the past, but never so many states, all at once,” said William T. Pound, executive director of the National Conference of State Legislatures.

The revenue pools are shrinking for a number of reasons: Rising layoffs are cutting into payroll taxes. The credit crisis and housing slump are affecting taxes levied on real estate deals. Sales taxes are shrinking as shoppers worried about the economy stay home.

Every state in the union but Vermont legally requires a balanced budget. So state governments have begun cutting.

In Utah, Gov. Jon Huntsman Jr. called the Legislature back for a special session last month to slash $270 million with an across-the-board 3% budget cut. Virginia Gov. Tim Kaine this month disclosed a sudden $900-million budget gap and announced 500 layoffs, the suspension of 2% raises for state workers and a hiring freeze. Georgia, faced with a $2-billion shortfall, is contemplating cuts of up to 10% at state agencies. Lawmakers are also discussing eliminating funding for the state’s Music Hall of Fame in Macon. When legislatures convene in January, they will have to consider even harsher reductions, warned Donald J. Boyd, a senior fellow at the Rockefeller Institute of Government in New York, who tracks state budgets.

“What states have done so far -- still generally mild -- pales in comparison to what they will do,” he said.

The pain will probably spread beyond the warrens of state bureaucracy as laid-off state workers and curtailed government spending help fuel a vicious economic cycle. The Center on Budget and Policy Priorities -- which typically takes a liberal view on policy issues -- notes that as the economy declines, residents require more services from their state government, not fewer.

The only alternative to cutting services -- a tax increase -- has proven unpopular in a number of states, including California and Florida. As a result, said Florida Democratic state Rep. Ron Saunders, “we’re doing what families are having to do. Most people I know don’t have the same discretionary income they had last year, so they’re facing difficult decisions.”

Some of the most dire problems are emerging in states such as California and Florida, where the housing collapse has been the most pronounced.

California lawmakers, who faced a $15.2-billion deficit going into the fiscal year, argued over the budget for months. In the final draft, state services took a big hit: Medi-Cal was temporarily cut by 10%, and the education budget was set at $3 billion less than last year.

The bad news continues to mount. Last month, the state’s revenue fell about $1 billion short of projections. Gov. Arnold Schwarzenegger and legislative leaders have been meeting weekly to discuss the problem and are considering calling lawmakers to a special session. In Florida, lawmakers faced a similar challenge as they wrote their yearly budget. The plan they devised was nearly $6 billion smaller than the year before. It resulted in 200 net job losses, tuition increases, cuts to nursing homes and the shuttering of 13 driver licensing offices.

Now the Legislature is scrambling to patch a new $795-million gap. Lawmakers may face yet another multibillion-dollar shortfall when they sit down to craft a budget for the fiscal year starting in 2009. Declining revenue is just part of the problem in Florida: Education costs are soaring because of the passage of a 2002 class-size-reduction ballot initiative, and rising enrollment and healthcare costs are bloating the Medicaid program.

Budget woes engulfed more than 40 states beginning in 2001, a result of the dot-com crash. At the time, economists said it was the biggest fiscal crisis for states since World War II.

“If you look at some of the basics of the economy -- unemployment, the stock market decline, the decline in consumer spending -- there is some reason to fear this crisis will be worse,” said Nicholas Johnson, an analyst with the Center on Budget and Policy Priorities.

Local governments, in particular, may get hammered harder this time around. In 2001, Johnson said, cities and municipalities, flush with cash from high property tax rolls, were able to pick up the cost of services that states had abandoned. But that will be more difficult now because declining home values have dragged down property tax revenues.

States have generally been conservative with their spending priorities since the last downturn, even as the housing boom swelled their coffers. Johnson noted that states, taken as a whole, set aside record reserves: At the end of the 2007 fiscal year, their total reserves of about $69 billion equaled about 10.5% of their combined budgets.

In Washington last week, House Democrats addressed the issue, saying they would consider giving aid to struggling states as part of a $150-billion economic stimulus package. Illinois Sen. Barack Obama, the Democratic nominee for president, has also proposed a multibillion-dollar aid package for state and local governments. Republican John McCain’s campaign did not respond to multiple inquiries about their candidate’s plans to help states.

The reversal of fortunes has been dizzying for states such as Arizona. Only two years ago, the state was sitting on a $1.5-billion surplus, but the housing collapse sent the economy into a tailspin. When Gov. Janet Napolitano signed the budget this summer, it was already tightened to close a $1-billion deficit. The state drained its reserve funds, took $18 million that was to be used for maintenance at small airports and instituted a hiring freeze.

But the financial situation has worsened in the last couple of months, and Arizona faces an additional deficit of as much as $800 million.

Napolitano earlier this month said that all expenditures over $50,000 would be reevaluated in light of the worsening financial picture. Officials warned that reductions in services may be inevitable. And they don’t know when the bad times will end.

Historically, fast-growing Arizona has been among the first states to recover from a recession, said the governor’s spokeswoman, Jeanine L’Ecuyer. “But we’re in a whole new ballgame now,” she said.

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richard.fausset@latimes.com

nicholas.riccardi @latimes.com

Fausset reported from Atlanta, Riccardi from Denver.