Columnist: Fiscal Doom for States: Are There Ways Out?

August 5, 2012

by Neal Peirce

It's tough to see any daylight in the recent blue-ribbon report on finances of the 50 state governments, issued by a task force headed by Paul Volcker, former chairman of the Federal Reserve, and Richard Ravitch, recently New York lieutenant governor and a chief author of New York City's fiscal recovery plan of the 1970s.

State governments, they report, "are grappling with an unprecedented fiscal crisis" -- exacerbated by the 2008 economic nosedive, the worst since the Great Depression, but rooted as well in years of state capital-generated fiscal gimmickry such as off-budget agencies, borrowing cash from future years' budgets, underfunded retirement promises to public employees, and more.

And even worse is likely to come, the Volcker-Ravitch State Budget Crisis Task Force reports. The U.S. economy is likely to grow sluggishly for years as it works off the excesses of the credit and real estate bubbles combined with slow job gains. The American population is aging fast: The ranks of the elderly, which grew 13 percent in each of the last two decades, are projected to expand 30 percent to 35 percent in this decade and again in the 2020s. This means a big, productive age cohort not just beyond work years but simultaneously seeking health and other public benefits.

Next alarm factor: states' pension funds, already seriously underfunded and unlikely to produce the high yields (6 percent to 7 percent yearly) predicted before the recession. Plus, states and localities, without any reserve funds for the purpose, have promised their workers hundreds of billions of dollars' worth of retirement health benefits.

Currently, Medicaid is the biggest single budget challenge for states -- indeed, the program has already surpassed state outlays for K-12 education and is likely to grow somewhere between 8.1 percent a year, if the health care reforms of the Affordable Care Act are implemented, and 6.6 percent, if not.

And another massive hit could strike as early as next year: potentially massive cutbacks in federal aid to states and local governments as Washington finally starts to come to grips with its trillion-dollar deficits.

Possibly on the chopping block, if this happens: big chunks of today's federal grants for schools and colleges, highway and transit support, community and regional development programs, housing assistance, pollution control and social service activities.

Altogether, Washington now provides grants to state and local governments of more than $600 billion a year. If Washington reduces just 10 percent of that ($60 billion) in an overall budget deal, the cost per person could run $316 in New York, $179 in California, $180 in Illinois or $133 in Virginia. A typical state, to keep its budgets intact, might be obliged to more than double its corporate taxes, cut police and fire spending almost in half, or eliminate all spending on libraries, parks and recreation.

Even before all this, most states had serious budget dilemmas. Reduced personal incomes hit hard at income and sales tax yields. States' take from corporate taxes has been dramatically eroded by business lobbying and legal tax avoidance. Gas tax yields are cut by reduced motoring and rising fuel efficiency. States' sales tax bases are further -- and seriously -- eroded by Internet-based transactions.

So what's to be done? The task force suggests states create "rainy day" funds to get them through hard fiscal straits. In normal times, this would be a nice move -- though one has to wonder how, in today's fiscal hail storm, states will find ways to build surpluses for even tougher times.

Surprisingly, the report doesn't point to one rich revenue potential: expansion of states' sales taxes to the lucrative base of services that generally aren't taxed today, from legal and financial counsel to newspaper and Internet advertising. In a "service economy," where else should one look for new revenue?

There is a suggestion that states should unshackle local governments, which are facing their own fiscal crises, from the many limits that legislatures have imposed on local property taxes. The argument is trenchant: If a community is willing to tax itself more for services it considers vital, what business is it of state legislators to stop it?

But the Ravitch-Volcker report's overall conclusions are deeply pessimistic. Beyond familiar, temporary state cutbacks in recessions, the panel of experts detects "a willingness to 'unbuild' state government in a way that has not been done before." Just one example: serious cutbacks in funding for courts, with big delays in bringing cases to trial -- raising the specter of "justice delayed" as "justice denied."

Is an "unbuilt" America inevitable? Let's hope not. Efforts to keep school staffs intact, to stop deterioration of public hospitals, to move ahead with crucial investments in infrastructure aren't luxury or froth. Sure, all can be made more efficient. But they're indispensable to our shared national future.

Neal Peirce's email address is nrp@citistates.com.

(c) 2012, The Washington Post Writers Group

The opinions expressed in this column are not necesssarily those of the National League of Cities.