Six months ago, states were predicting balanced budgets and surpluses. Virtually all had surpluses at the end of fiscal year 2007 and more than half had ending balances equaling at least 10 percent of their general funds. Governors and legislatures were happily talking about property tax relief and expanding medical coverage to the uninsured.
How times have changed. According to the Center on Budget and Policy Priorities about half of all states now expect a budget shortfall in FY '09, with the number growing as more states release their budgets for the coming year. Seventeen states expect deficits totaling at least $31 billion, and California and Maryland anticipate shortfalls in the current year as well. It is looking like states will have a much tougher time weathering the current downturn than they did in the last two recessions.
Why? One reason is that in 2001, after spending down rainy day funds, states were able to limit their own fiscal pain by cutting aid to cities, counties and school districts. Local governments were able to make up the lost funding because their major source of revenue—the property tax—was booming thanks to a huge rise in home values. Shifting the pain downward won't be so easy this time, with property values plunging and homeowners demanding cuts in assessments. Cities are also anticipating their own budget tightening, with Mayor Bloomberg proposing budget cuts and anticipating deficits for New York City for the foreseeable future
The stimulus plan agreed to by President Bush and the House excludes aid to states, although there has been some talk about addressing this issue in a second bill later this year. However, states have no choice but to balance their budgets, since, unlike the president, governors can't print money. That will mean after spending down their surpluses that states will have to cut spending or raise taxes, actions that will partially undo the benefits of any federal stimulus.
Last time around, the federal government provided $20 billion in aid to states. Half was a temporary increase in the federal share of Medicaid, and half was a general grant to states based on population. Although it didn't come until 2003, after the recession ended, it still helped.
This time, the feds might want to think about ways to target relief to those states experiencing the most trouble—often those hardest hit in the housing crisis. Sadly, it seems like they will have plenty of time to act since the hit to state and local budgets seems likely to go on for a while, along with the downturn in property values.
