States Facing Up To Slowing Economy

State budgets are being squeezed.

On one side, a slowing national economy is decreasing the amount of money flowing into state coffers. On the other, increasing Medicaid and in some cases prison and welfare costs are pressuring states to increase spending. And things may get worse before they get better.

That was the consensus of two reports released Wednesday on the fiscal health of the states.

"Clearly a large number of states are seeing their fiscal positions deteriorate. While the affects are being felt around the country, states facing the most serious challenges are in the Southeast and Midwest, which depend on manufacturing and rely heavily on sales taxes for revenue," said Raymond Scheppach, executive director of the National Governors Association.

The NGA delineated its position in The Fiscal Survey of the States, a biannual report released Wednesday and co-authored with the National Association of State Budget Officers. Also released Wednesday was The State Revenue Report for the first quarter of 2001, written by The Nelson A. Rockefeller Institute of Government at the State University of New York, Albany. Though not coordinated efforts, both reports forecast similarly dour economic conditions for the states.

According to the NGA-NASBO report, a second consecutive quarter of slow revenue growth has many states approving their smallest spending increases since the recession of the early 1990's. For the upcoming fiscal year, which for all but four states begins July 1, states are raising spending 3.4 percent, the smallest increase in state general fund spending since 1993 and little more than half the average annual increase over the past six years.And in a sign that many states are being caught off-guard by the deteriorating economy, an ad-hoc survey conducted by NASBO reveals that at least 16 states recently cut their already-approved budgets for the 2001 fiscal year. Seven of those states have made across the board cuts, with some making exceptions for education spending. Last year, only one state had to cut its budget post-enactment.

Both studies report that the states of the Midwest and the Southeast are being hit hardest due to their heavy reliance on manufacturing for economic growth and sales taxes for revenue. Most of the jobs lost over the past few months have been in manufacturing, while service sector jobs have continued to grow, notes the Rockefeller report. This explains the still strong performance of the economies of New England and the West. But, according to the Rockefeller report, there are signs that the slowing is spreading to other parts of the country.

Despite stormy fiscal forecasts and some projected budget deficits, few states will be passing major tax increases to ease their way out of budget difficulties. More likely are fee increases and targeted tobacco and alcohol taxes or even lotteries tied to the funding of specific programs. Some states have also instituted hiring freezes to hold down spending. "Tax increases seem to be off the table in most states," said Scheppach in a press conference announcing the NGA-NASBO report.In fact, the states are projected to pass a net tax cut of $676.8 million for the year, according to the NGA-NASBO report. This will be the eighth consecutive year states have passed net tax cuts, but this year's figure pales in comparison to past cuts, notably last year's $5.8 billion reduction. Most of this year's cut will come from further reductions in state income taxes. State revenue will also be affected by the recently passed federal tax cut, most importantly the phase-out of the estate tax. Over the next ten years states may lose between $50 and $100 billion due to the estate tax phase-out, according to the NGA. The major variable in this taxing and budgeting equation is the performance of the economy. And at this point its performance remains rather unpredictable. A general slowing has been noted by most observers. But whether the economy will start to recover or deteriorate further over the next year or two is a question that remains unanswered.

Still, both reports warn that a recession, or even a continued slowdown, will have serious consequences for state coffers. And neither seems to place much hope in a quick turnaround.

"If things continue down they may have to make more cuts," said Scheppach at the press conference. The Rockefeller report closes with a more ominous warning: "States will have to monitor the slowing economy and revenues carefully to avoid serious trouble in the coming year."


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