Cliff Diving in 2011: State Budget Woes Create a Black Hole for U.S. Stimulus Funds

From Knowledge@Wharton:

Arizona is considering putting its House and Senate buildings up for sale. Connecticut's governor proposed a $1 per-pack tax hike on cigarettes. Michigan's House Speaker suggested shifting its 400,000 public employees to a single health care plan, while another Michigander urged the reclassification of soda pop as a non-food item so it could be taxed at 6%.

From California to Connecticut, the global recession has squeezed state finances, forcing many state governments to slash services, raise taxes or find unusually creative ways to close the gap. The widespread budget shortfalls -- expected to continue through at least 2011 -- threaten to put a drag on the nation's economic recovery and undermine President Obama's stimulus plan, according to Wharton faculty and other experts.

Indeed, much of the more than $230 billion that the federal government sent to the states to stimulate their economies over the next two years is instead being used to balance budgets. "The states aren't really playing the game like Obama hoped they would," says Wharton finance professor Robert Inman.

"The dire condition of many states is a direct result of the financial crisis," according to Wharton finance professor Itay Goldstein. "States depend on tax revenues, which decline in times of crisis due to rising unemployment, lower salaries, less spending, etc. Also, states depend on the credit market to smooth cash availability. [The credit] market has been in a freeze during the crisis, and this makes it more difficult to get financed. You combine these factors ... and you get difficult times for states, just like for firms and individuals."

At least 48 states either addressed or still face shortfalls totaling $163 billion in their budgets for fiscal year 2010, according to a recent report from the Center on Budget and Policy Priorities, a Washington, D.C.-based research center. A month after July 1, when the fiscal year in most states began, five states -- Arizona, Connecticut, Michigan, North Carolina and Pennsylvania -- remained deadlocked over how to balance their budgets. At least a dozen more states discovered billions in new shortfalls almost immediately after passing their budgets.

If projections are correct, the pain for most states won't end anytime soon. The National Conference of State Legislatures (NCSL), a Denver-based bipartisan organization that serves state lawmakers and their staffs, estimates that the cumulative state budget shortfall for fiscal years 2008 through 2012 could top $348.2 billion.

Cliff Diving in 2011

"Many states say they are looking at a cliff in 2011 because they know [the federal stimulus funding they will have received from the American Recovery and Reinvestment Act of 2009] will be gone, and they do not expect state revenue performance to rebound strongly enough to make up the difference," the NCSL reports in its recent State Budget Update for July 2009. "Many states are looking at a minimum of four to five consecutive years of deep fiscal problems.">>>MORE