States' tactic to stem red ink: borrowing

As 46 states turn the calendar to a new budget year, it is becoming clearer that many have put off until next year what they could not - or would not - handle now.

The unprecedented size of state deficits, swollen by dour economic factors unseen since the days after World War II, has played a part. Yet so has a new caution by state legislators, who have proved unwilling to significantly raise taxes for fear of a revolt like the one that launched the 1994 Republican Revolution.

The result is not only heightened gridlock, as an unusually high number of states passed yesterday's deadline with no fiscal plan, but also the rise of a budget tool rarely used in America's statehouses: borrowing.

While the federal government has pushed its debt into the trillions to finance programs and tax cuts, states have historically avoided borrowing - discouraged by tangled rules and balanced-budget requirements. But deficit spending, as well as deferring payments and borrowing against tobacco-settlement funds, have provided an escape hatch for legislators desperate to avoid cutting teachers or raising sales taxes.

The strategy amounts to a stalling tactic, as statehouses hope for an economic turnaround. With no reversal in sight, it poses the risk of simply creating greater challenges in 2004 - and swallowing any future recovery in a tide of interest payments and overdue bills.

"There's been a lot of borrowing - more than we normally see in down times," says Claire Cohen, a state analyst at Fitch Ratings credit agency in New York. "Overall, I don't think that the problem has been faced, and that means the problems will just last longer."

In the past two years, credit agency Standard and Poor's has downgraded the bond ratings for six states, due in part to their increased use of borrowing. Among them, Wisconsin and New Jersey have relied heavily on loans that will be paid back by tobacco-settlement money. Other states, including Oregon and Connecticut, have floated bonds solely to pay off their deficits.

In addition, many states have delayed payments to pensions or shifted expenses from June to July so that it won't appear on the current budget. "States are doing more and more things that amount to borrowing," says Nicholas Johnson, an analyst at the Center on Budget and Policy Priorities in Washington.

To some degree, financial analysts understand that borrowing is necessary. The scale of the problem defies any one solution. While states continue to grow, adding more children to schools and more residents to healthcare rolls, states' incomes have hardly budged for more than two years. The lack of inflation has meant no rise in sales taxes; stagnant wages - combined with a rise in unemployment - have meant no rise in income taxes; and the bountiful capital-gains taxes of the 1990s have evaporated.

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