President-elect Obama plans middle-class and business tax cuts to stimulate the economy, but the impact of those cuts could be softened by state governments trying to hike taxes and fees to close the worst budget gaps they’ve seen in decades.

Most states face a budget shortfall this year. New York and California each face gaps of approximately 25 percent of their total budgets.

That means possible taxes on gasoline – passed in Minnesota and Nevada last year and proposed in California – as well as fee hikes on everything from boats to cars, libraries, and parks. New Hampshire and New York raised cigarette taxes and Indiana has raised sales taxes.

The situation also means forgoing proposed or planned tax cuts. Florida canceled a sales tax holiday and California has suspended net operating loss deductions.

“States are telling us their revenue situations are a disaster,” says Arturo Pérez, analyst for the National Conference of State Legislatures in Denver. “They are looking at every possible way to make up for billions in lost revenue.”

These comprise both spending cuts and tax hikes. Iowa is cutting back on schools, Kentucky is cutting library hours, and Minnesota, where the Republican governor has said he will not raise taxes during a recession, is proposing to cut $5 billion from state services.

Illinois is contemplating an 8 cent gasoline tax to raise $7 billion and one proposal in California is for a 13 cent per gallon tax, which would help raise $9.5 billion.

At a conference of US state legislators December, Standard and Poor economist David Wyss told legislators to first consider hiking gasoline and sales taxes.

Still, tax hikes remain an unpopular solution. Despite the severity of the 2001 recession – the worst in 50 years at that time – there were few tax increases, according to Donald Boyd, fiscal analyst for the Rockefeller Institute for Study of the States. But this time around, the recession is worse, he says.

All told, 40 US states are reporting an estimated $150 billion in budget shortfalls.

California’s crisis

In California, where state finance director Mike Genest declared that this is “probably the most challenging budget situation the state has ever faced,” legislative Republicans have blocked several of Gov. Arnold Schwarzenegger’s tax hike proposals.

As the legislature convenes this week, it will examine the governor’s proposal for $14.3 billion in tax increases in addition to $17.4 billion in spending cuts over the next 18 months.

The state is attempting to close a projected $41.5 billion shortfall.

Mr. Schwarzenegger has already signed an executive order forcing 235,000 state workers to take two furlough days a month starting Feb. 1 and required a 10 percent cut for state agencies, which could lead to thousands of layoffs.

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