States out of the red but still seeing red

States are finally bottoming out from a wrenching three-year dip in tax revenues - a shock made even more jarring by comparison to their 10-year run of record black ink in the 1990s.

Dozens of states report deficits of zero this month, as lawmakers have closed gaps that reached $80 billion last year and $200 billion since 2001. The improvement comes on the back of the country's recent leap in economic expansion. More-conservative spending plans have also helped.

But even as they begin to catch their breath, states are hunkering down for a whole new era of long-term needs, which could prompt continued tax overhauls, spending constraints, and efforts to "reinvent" government.

Chastened by tenacious catfights over taxation and programs, and eyeing major battles ahead over healthcare costs, education, and other issues, the bold and conservative alike aren't declaring budget victory just yet.

"States are [beginning] to look at what problems they have encountered because of tax structures and program outlays that are no longer tenable," says Arturo Perez, an analyst for the National Conference of State Legislatures. "Many have shifted away from the kinds of economies they had when current programs and taxation laws were put in place. And they are chastened by the scope of issues on the horizon that could come along and make their lives miserable."

It is now clear that the greatest economic expansion in US history, during the 1990s, was a historic anomaly that may never come again, state budget analysts say. Anyone who is still relying on models of tax revenue or government services from that era is living in a dangerous dream (witness the California deficit and recall election, they say). Healthcare, already the biggest outlay for most states budgets, will be the biggest issue, as will long-existing formulas for services from education to corrections.

"States are really beginning to rethink many of the ways they've been doing things for decades," says Nick Jenny, an analyst at the Rockefeller Institute for the States. "For 10 years they were able to spend more and cut taxes at the same time - and many got used to that as a way of doing business. Now they are really going to have to decide what their priorities are for the long haul, based on much more steady and normal growth."

Virginia is one case in point. Gov. Mark Warner (D) has warned he will keep the legislature in special session, if needed, to force action on a plan to revamp the state tax structure. The state has a strong credit rating, but even an improving economy isn't expected to resolve its problems.

"We have ... a structural imbalance through the end of the decade," Mr. Warner said last week, according to the Associated Press.

In Virginia and elsewhere, however, new taxes aren't an easy answer. Though new levies were embraced by many states after the recession of the late 1980s, voter wrath has lately felled both tax proposals and pro-tax candidates coast to coast. Meanwhile, the income streams many states have grown more volatile - and can fall victim to lower stock-market income or smaller bonuses at work. Sales taxes, instituted by most states by the 1930s and long the primary source of state income, were surpassed in volume by income taxes in 1998 - a more volatile revenue stream that can wreak havoc on state plans.

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