States’ Revenues Now Sagging Under the Weight of Recession

They held out, hunkered down and bought time where they could. But one by one, the states are becoming casualties of the recession.

As their revenues decline and reserves dwindle, state governments are responding to the downturn just like distressed private-sector enterprises--cutting costs, reducing work forces, deferring investments.

Next week, Michigan will lay off prison guards as part of its emergency plan for erasing a huge budget shortfall. Colorado has called off highway projects that would have created new work for road contractors just about now. As the cycle plays out in state after state, fewer dollars change hands, less work gets done, more people lose jobs.

“We have our people and our equipment and our supplies ready, but we haven’t seen any [contracts] since September,” said Mary Ann Ivey, who lobbies for the Colorado Contractors Assn. “This could get very, very serious in short order.”

The states are contributing to the recession despite efforts by the federal government to push in the other direction. In the last year, Washington has sent out $38 billion in tax rebates, approved $40 billion in emergency spending, and cut interest rates 11 times in an attempt to turn things around.

For the most part, the states have little choice. Every state except Vermont has a constitutional or statutory mandate to keep its budget in balance. Deficit spending, a potent recession cure when administered properly, is forbidden.

“States have to balance their budgets, unlike the feds. So they tend to cut services and increase taxes, both of which have a depressive effect on the economy,” said Nicholas W. Jenny, senior policy analyst at the Nelson A. Rockefeller Institute of Government in Albany, N.Y. “It tends to contribute to the cycle rather than being counter-cyclical.”

The budget woes are beginning to snowball. According to a new study by Jenny, state tax revenues fell 5% during the July-to-September quarter, after adjusting for inflation and tax law changes. It was the first decline since the end of the 1990-91 recession. California and other Western states took some of the biggest hits.

The states’ combined budget shortfalls had reached $40 billion by early December, and could rise to $50 billion in early 2002, according to the National Governors Assn. That amounts to roughly 10% of state revenues, the highest level ever recorded. The governors blamed the deficit on plunging tax collections, soaring health care outlays and post-Sept. 11 homeland security costs.

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Using a Variety of Defenses

Moody’s Investor Service warned last week that some states will remain under fiscal stress long after the national economy begins to recover, particularly those dependent on tourism, manufacturing and financial services. The number of states with “negative outlooks” was increased to 13 from four. California was put on the list earlier this year.

States are responding to the fiscal crunch with a variety of defenses. According to a survey by the National Conference of State Legislatures, 36 states have implemented or are considering budget cuts, and 22 have adopted belt-tightening measures such as hiring freezes, travel restrictions and capital project cancellations.

In addition, 24 are tapping rainy-day funds, tobacco settlement proceeds and other reserve accounts, reversing nearly a decade of accumulation. Over the last two years, states have withdrawn more than $15 billion from savings.

Seven states--Alabama, Arizona, Connecticut, Florida, Illinois, Iowa and Nebraska--have convened special legislative sessions to grapple with budget problems. The bloodletting is expected to intensify in early 2002 as governors and lawmakers begin drafting austerity budgets for the next fiscal year.

Arturo Perez, senior policy specialist for the legislatures conference, said states tend to cut discretionary spending first, by calling off construction projects, postponing new hires and cutting back on purchases and travel.

“States try as much as possible to avoid cuts that affect client services, whether it’s a faculty member at a higher education institution or somebody behind the counter at the Department of Motor Vehicles,” Perez said.

But even if state payrolls can be preserved, that doesn’t mean jobs aren’t endangered.

Within days of the Sept. 11 attacks, Colorado canceled bid solicitations for $173 million in highway projects scheduled to begin this year. It expects to call off $225 million in jobs next year, and cancel a $409-million highway bond issue.

The Colorado Department of Transportation says thousands of construction jobs could be jeopardized by the deferrals, a prospect that has rattled the state’s road-builders.

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More Projects Being Deferred

“This is a very big hit for us,” said Laurie Freedle, deputy finance director for Colorado’s transportation department. “This is about 20% of our budget.”

Other capital projects are being deferred too. The University of Colorado has postponed construction of a new law college in Boulder. The University of Maryland won’t get a new dentistry school. In Bristol, R.I., a $60,000 roof replacement at the Rhode Island Veterans Home has been called off.

To reduce payroll expenses without terminating workers, some states have adopted the private-sector practice of trimming through attrition. California and half a dozen other states have imposed hiring freezes as they prepare for more wrenching budget adjustments next year. Illinois is requiring 60,000 state workers to work a day without pay, a move that will save the state $8 million.

At some point, if the fiscal squeeze is severe enough and the less painful reductions have already been made, states may be forced to cut where it hurts.

Two weeks ago, Michigan sent layoff notices to 244 corrections employees. Most work at the maximum-security prison in Jackson, which is being closed as part of a budget-cutting plan approved by lawmakers last month. The layoffs will take effect Jan. 5.

“It was like a total surprise,” said corrections officer Richard Henrizi, who received his notice Dec. 10. Because he thought he had enough seniority to avoid the ax, Henrizi didn’t put in for a transfer when first given the opportunity. He has filed a belated request but hasn’t heard back.

Henrizi, 40, said he knows the funding crisis is real but resents the way it was handled. “The governor and all his legislators, they take a 38% pay raise and then say, ‘Oops, the budget is screwed up, we’ve got to lay everybody off.’ That’s totally wrong.”

Ohio will follow in Michigan’s footsteps when it begins shutting down a 1,700-inmate prison in Orient. Most of the facility’s 525 employees will be laid off by April.

South Carolina, one of the first states to get caught in the recessionary squeeze, began laying off state employees earlier this year. So far, 350 have been targeted, many of them mental health workers. In Idaho, about 40 health and welfare employees will soon receive pink slips. Florida Gov. Jeb Bush just signed a $1-billion budget-balancing measure that will eliminate more than 1,800 state jobs.

So far, only a handful of states have been willing to consider tax increases. North Carolina boosted its sales tax by half a cent and made wealthier households pay more income tax. Florida deferred a scheduled tax cut for owners of stocks and bonds. Ohio closed some business tax loopholes.

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‘The Worst Thing You Can Do’

It’s a bitter pill, particularly for states that took advantage of the 1990s economic boom to jump on the tax-cut bandwagon.

Yet in the view of some analysts, raising taxes may make more sense than reducing spending.

“If you cut state spending, you’re putting less money in the state economy,” said Iris J. Lav, a deputy director of the Center on Budget and Policy Priorities in Washington. “That’s about the worst thing you can do, because it deepens the recession.”

Nobel laureate Joseph E. Stiglitz and economist Peter R. Orszag of the nonpartisan Brookings Institution argued in a recent paper that tax hikes do less damage to the economy during a downturn than an equivalent amount of spending cuts. That’s because only a portion of each dollar would have been spent if the government had not taxed it; the rest would be put aside as savings, which provides less stimulus to the economy. Spending cuts, on the other hand, reduce economic activity on a dollar-for-dollar basis.

Moreover, some of the spending cuts imposed by states affect Medicaid and other social services programs targeted at the poor, who tend to spend every dollar they receive. Kentucky, Indiana and Mississippi have reduced Medicaid outlays already, and more states are expected to follow.

For that reason, advocates have urged the federal government to include aid for the states in any new package of economic stimulus measures. The National Governors Assn. proposed a temporary increase in the federal share of Medicaid costs.

Although efforts to pass a stimulus bill ended last week in gridlock, the states may press their case when Congress reconvenes in January.

Mark Zandi, chief economist at Economy.com in West Chester, Pa., said the states can play a critical role in cushioning the recession’s blow because they can get money into the hands of distressed households quickly and efficiently.

“It’s a huge mistake for the feds, in their fiscal policy discussions, not to be thinking about giving money to the states,” Zandi said.