The Budget Knives Are Out

Up until the end of last year, before share prices dove off a cliff and people starting taking the myriad signs of impending recession more seriously, the rose-colored glasses set was insisting that 1) bullish stock traders knew best and 2) the American consumer would somehow manage to keep on spending.

In reality, both of those assumptions, like the idea that the bursting of the biggest credit and housing bubbles in history would not have widespread implications, have proved wide of the mark. In "States to Tighten Belts as Weakness Of Economy Cuts Into Tax Receipts," the Wall Street Journal reports on yet one more development that many of the so-called experts missed the boat on but which has clearly been on the cards for a while.

Slower growth in tax revenues, the result of a weakening economy, are prompting governors from New Jersey to California to consider an array of belt-tightening measures to balance their budgets for this year and next.

Facing a severe revenue shortfall, Kentucky Gov. Steve Beshear has asked most state agencies to trim their spending by 3% in the current fiscal year, which ends June 30. New Jersey Gov. Jon Corzine has proposed raising tolls and freezing spending to reduce his state's debt. And California Gov. Arnold Schwarzenegger, in a bid to avert a deficit in the coming fiscal year, has proposed closing state parks, eliminating dental care for the poor and cutting $4 billion from the state education budget.

"There are going to be very difficult -- but very necessary -- reductions to close the spending gap," says H.D. Palmer, a deputy budget director for California. "By definition, closing a $14.5 billion budget gap is difficult."

In last year's third quarter, state tax revenues overall were up 4.4% from a year earlier, according to a report scheduled for release today by the Nelson A. Rockefeller Institute of Government at the State University of New York. But, after adjusting for inflation, they were down 0.6%. That was the first year-to-year decline in four years.

Much of the shortfall stemmed from the slowing economy, as well as tax cuts enacted by some states for 2007. While revenues from personal-income taxes have remained healthy, growth in sales-tax revenues has slowed as consumers have reined in their spending, and income taxes collected from corporations have fallen, along with corporate profits.

"This could be a very tough year for states," says Robert Ward, the Rockefeller Institute's deputy director. "The bad news is it's fairly widespread."

Belt-tightening by the states could further damp the nationwide economy. State and local governments account for about 9% of gross domestic product, and they have been a steady contributor to economic growth in recent years. Their spending grew at a 19.4% pace last year and at a 6.1% pace in the third quarter.

This is the time of year when governors give their "state of the state" speeches, and over the next few weeks they will be presenting budgets to their legislatures. Unlike the federal government, most states are required by law to balance their budgets.

Bracing for Cuts

Most states don't have to pass a budget until the middle of the year, but already, state agencies and their employees are bracing for cuts. In Alabama, the state's teachers lobby has said it probably won't seek a pay increase in 2009, and instead will focus on preserving health benefits. "There's no likelihood of a pay raise because the economy is going south," says Alabama Education Association spokesman David Stout.

The budget picture could be much gloomier than the third-quarter revenue figures indicate. Evidence suggests consumers have continued to pull back on spending. Last week, companies including retailer Kohl's Corp. issued profit warnings, citing slower sales.

In many places, the slump in home prices has reduced revenue from property taxes and taxes levied when houses change hands. In most cases, these taxes are collected by local -- not state -- governments. But a deteriorating real-estate market also strains state coffers, which depend heavily on sales taxes, by making consumers feel poorer and thus less inclined to spend on things like home furnishings, new cars and dinners out.

Only a few states, including New Hampshire, Ohio and Nevada, saw an overall decline in third-quarter revenue, according to the Rockefeller Institute. Nationally, the weakest link was corporate income taxes, which declined 2.4% from a year earlier. Sales taxes grew at a 3.1% rate, unchanged from the previous quarter. Income taxes increased 6.3%, less than their year-to-year increase of 8.7% in the second quarter.

States that saw some of the highest run-ups in real-estate prices -- including California, Nevada and Arizona -- have some of the worst of the budget problems. Revenues in California increased just 2.8% in the third quarter from a year earlier, Arizona's take increased 0.8% and Nevada had a 4.1% decline.

In Florida, overall state revenue declined 6.7% in the third quarter from a year earlier, the biggest drop of any state, according to the Rockefeller Institute. The decline was led by corporate-income taxes, which fell 15.4%, while sales taxes were down 3.5%. Florida has no personal income tax. The state recently projected that falling tax revenues would force it to cut as much as $600 million from the budget for the current fiscal year, which ends in June.

Florida's legislative session doesn't begin until March, but politicians already are discussing remedies. House Speaker Marco Rubio has suggested that the state could eliminate or consolidate some state agencies. Other ideas include tapping rainy-day reserves to make ends meet or raising revenue by adding new games to the Florida lottery.

Budget Mess

Many states were in a budget mess in 2001 and 2002, when the bursting of the tech-stock bubble hammered personal incomes, especially among wealthy taxpayers. But consumers quickly regained their footing, and rising real-estate prices and the subsequent home-refinancing boom boosted consumption -- and sales-tax revenues -- even more. Between 2004 and 2005, the peak of the latest cycle, states enjoyed year-to-year increases of 7% to 12.9% in their quarterly revenues.

One critical difference between today's budget squeeze and the last: the effect on local governments. Property values held steady after the tech bust, so local governments, which rely on property taxes for much of their funding, were shielded from the blow. But the current drop in property values is squeezing local budgets and could force deep spending cuts at the local level as well.

"When state budgets get tight they push programs down to the local level," says Robert Kurtter, managing director in U.S. public finance at Moody's Investors Service.

Comments

[Scott Frew]

Mike--

New Joisey may be doing some anticipatory belt-tightening, but don't discount the fact that simultaneously, its investment division has anted up in the rescues of Citi and Merrill. The number $700 million is what I remember from this morning's reading, although somehow it eluded me on a quick look for it to doublecheck just now. But the success of those investments will surely alleviate pressure on state retirement plans down the road. I seem to recall that Corzine, who I think is still the governor, used to hold a job at Goldman Sachs. Same position there as was held previously by Robert Rubin, who, as I recall, has some sort of current connection with Citi. Ain't the old boy network wonderful? And aren't the good citizens of the Garden State fortunate to have such knowing leaders looking out for their interests, and for nobody else's.

Just fyi, Portales Partners noted this morning that state and local government spending is 13% of the economy, larger than residential and non-residential construction combined. Yet another drag on gdp going forward.

Regards.

Scott

[farang]

After reading this article, and the direction of Arnold the Actor's "solutions" to balancing a budget $14.5 Billion in the Red, a few thoughts spring to mind...

I recall well the happy, smiling face of Arnold portrayed in the media when he came up with a Grand Solution to the last time my former state was billions in arrears (two years ago, three?): Borrow It. So Arnold, no problem now: Borrow It. What? Your neocon buddies have sprung the trap, the con has been pulled, no more "free money" when they are now betting short (Today's news: Greenspan joins firm that made billions shorting the subprime)? Better to balance it on the backs of the kids at public schools (were did your kids go, Mr. Austrian Immigrant?) and the poor's dental needs?

No, we think it better to raise taxes on those living in houses valued over $5 million by 5%, $6 mill by 6%, and so fourth, until you hit 50 mill, and keep raising their Property taxes, their Sales taxes and Income taxes until the budget is balanced. Unfair you say? Ok, we'll compromise: We'll include cuts. Across the board 25% cuts of pay and benefits for cops and prison guards. Call it curing the Dukmeijian/Wilson Hangover of binge spending on "lawnorder".
50% reduction in all elected officials retirement benefits and health care. Closing the State parks? We think not. Better we close the governor's mansion, and allow a multi-millionaire to live at home in SoCal, with his own private (and personally paid for) security entourage. After all, he is Conan the Barbarian, he can take care of hisself.

The Jig is Up. Votes tainted, paid liars masquarading as reporters on every news channel, the US Dollar in damn near freefall (What? What's going to rescue it? Invading Iran? We invent a new hamburger/pizza/chicken chain to franchise wordwide, WHAT?), absolutely no leadership on the sinking economy except more of the same. RAISE THE DAMN INTEREST RATES BERNIE!!!! SAVE OUR DOLLAR!!!

Sorry unqualified liars got liar loans from conmen banksters eager to make a buck, and are now being tossed from homes they didn't qualify for.

But, tough. They knew better, and if they didn't, well, tell a cop to arrest the conmen. But leave our dollar alone. Save my dollar. Raise the Rates. 9% sounds good, 11% better.

3. I recall another time in California. One with msm labeling our governor "Moonbeam." Calling the unfinished (and unfunded) highway projects he inherited from a certain sainted conservative (actor, that tripled my state taxes while in office, irrevocably harmed the best community college system in America, then went on to turn my country from the largest creditor nation, into the largest, by far, debtor nation. Destroyed major US airlines through "de-reg". All Hail Ronnie) "Brown's Follies", while California state tax payers collected rebate checks, because our budget was colored BLACK.

Who's "moonbeam", who conservative?

Oh yeah, and with an economicly conservative president in office then (Carter), I was rewarded for being fiscally conservative and saving my money with tidy $14% interest T-bills. Not to mention, the last two years of Carter showed the ONLY reduction in imported oil, thanks to his alternative energy program, which the unfortunately brain-addled actor promptly canceled upon taking office.

But, he did get to sleep sleep at a Granada Holiday Inn Express!!!

WHAT IS OUR COUNTRY'S DAMN ECONOMIC DIRECTION UNDER REPUBLICANS AND DEMOCRATS EXCEPT WAR AND DEBT AND DOLLAR DESTRUCTION???

[A. Zarkov]

The last time California had a budget deficit problem the governor tried to cut spending. In voting down his propositions, the voters said “no,” they don’t want cuts, and they don’t want to pay for the services either. In effect they cried, “do what we do: charge it.” And he did. Now CA is some $14 billion in the hole, and he declared a “financial emergency.” While he proposed some across-the-board budget cuts, he still wants to go ahead with an expensive new state medical insurance program to cover everyone including illegal aliens. How can we take him seriously? Does he think he can just keep selling bonds to pay expenses the way New York City did in the early 1970s? Look what happened to them. In 1975 their new issues didn’t sell and they were forced into default, something they cleverly called a “moratorium.” In the end they got rescued from Washington. Now is Washington going to bail everyone out this time? If Treasury issues more bonds they will drive up interest rates while the Fed is trying to lower them. I can see only one-way out for them: seigniorage-- the dreaded inflation tax that results from money creation. Of course this risks hyperinflation. In 1923 Germany, prices doubled every 49 hours until all wealth held has cash evaporated.