Will state budget cuts blunt the recovery?

State and city budget cuts could offset the federal stimulus's effects.

By , Correspondent

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    The recently boarded-up police recruiting center in Oakland, Calif., is one example of desperate measures by a hard-hit municipality. States and cities still wrestle with big budget gaps.
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Whatever oomph the federal stimulus gave the US economy, deficit-ridden cities and states are poised to take it away.

With two years of depressed tax revenues, a third one expected, and rainy day funds all but exhausted, state and city governments are having to close huge budget gaps. If projections are correct, they could amount to $660 billion from fiscal 2009 through 2012, nearly rivaling the $789 billion stimulus from the federal government. Although these governments are raising some revenues through tax hikes and new fees, mostly they're cutting spending. That threatens to reduce safety net services, push hundreds of thousands of workers onto unemployment rolls, and derail a fragile recovery.

"State and local governments are going to be a serious drag on the economy over the next 12 to 18 months," said Mark Zandi, chief economist of Moody's Analytics, a Pennsylvania-based economic research firm. Their budget woes could trim a half percentage point from the United States' growth rate this year, he estimated.

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Collectively, states must close a $127 billion shortfall for the 2010-11 fiscal year, says a National Association of State Budget Officers survey. Some states are in particularly bad shape:

California is on the brink of eliminating its entire $1 billion welfare-to-work program to close a whopping $19.9 billion deficit.

Arizona will cut some $1 million in Medicaid services in an effort to close a $3.1 billion deficit.

Colorado will slash education funding by $400 per student this coming school year.

That's for one year. Adding deficits in fiscal 2009 and 2010 with 2011 and 2012 projections from the Center on Budget and Policy Priorities (CBPP), the total comes to $602 billion.

Many cities are also in trouble. Boston will lay off 111 municipal and school district employees this year to close a $50 million budget gap, after letting 790 city workers go in 2009-10. Oakland, Calif., laid off 80 police officers, or about 10 percent of its force, to help close a $31 million deficit. Overall for the 2009-12 period, municipal deficits could add up to $43 billion to $73 billion, according to the National League of Cities.

The question now is what, if anything, Washington should do about it. Policymakers who voted for the stimulus now face a ballooning $1.5 trillion national deficit, and pressure from constituents to curb government spending. They're pulling back state aid in response.

Senate Republicans blocked a bill in June that would have extended stimulus Medicaid funding to the states through fiscal 2011. Now, funding is set to drop off in December. That's a $16 billion loss in additional aid, which some 30 states had already calculated into their 2011 budgets.

Deficit hawks say the shortfalls will force fiscal rectitude. "Government spending is so high, it needs to go down everywhere," said Kevin Hassett, a fellow with the American Enterprise Institute for Public Policy Research in Washington, D.C.

But many economists worry about the impact on the recovery.

"I understand the long-term concerns," said Kim Rueben, senior fellow at the Urban Institute in Washington. "But if they pull back too much now, the fact that the states are going to do things like increase taxes and make spending cuts, that's going to exacerbate the decline from stimulus."

Many economists view aid to states as a good way to boost the economy. "The reality is that every penny state governments spend goes right back into the economy – it's salaries, it's contracts," said Jon Shure, deputy director of the CBPP's State Fiscal Project. Mr. Zandi estimates that $1 in state aid creates $1.41 in stimulus.

Some states have taken unorthodox steps to close deficits. Most of them are short-term or one-time fixes, which adds to economists' worries that states may need the better part of a decade to reach budget stability.

Arizona sold its Capitol, its Supreme Court building, and other facilities in the spring to balance its budget. It is buying them back at a low interest rate. "You can only sell your state house once," said Ethan Pollack, of the Economic Policy Institute, a Washington think tank.

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