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.

Citizen and voter activism is predicted to play a bigger role in coming years, as several states wrestle openly with long-entrenched ways of doing business.

Exhibit A is California, where new Gov.

Arnold Schwarzenegger (R) is promising a whole new era of bipartisan cooperation to dig that state out of chronic budget deficits. A 67-member panel of appointees from across the political spectrum is looking into every aspect of how the state governs and pays for its services. Five year's worth of new programs and appropriations are on hold as the legislature meets in special session - with the threat that if legislators don't move quickly the executive branch will take them straight to voters in referendums

Exhibit B, a less-known but more typical fight, might be Oregon. A legislative tax surcharge to help close an $800 million budget gap was confronted last week with voter defiance: the submission of three times the necessary signatures to overthrow the legislation in a February referendum. Legislators, anticipating the promised referendum, have already written into the law a prescribed set of program cuts should the referendum pass.

"Taxes and program cuts here have become so contentious that everyone is getting in on the act," says Cindy Becker, assistant director for the state department of administrative services. Like California, she says, much of the state's income is already spoken for because of the constraints created by a slew of ballot measures in recent years. At the same time that property taxes have gone down, the state has 150,000 more kids, 37,000 more college entrants, 58,000 more on state health plans, 90,000 more on food stamps, and 2,500 more prisoners.

People are telling us you have got to run your state government more like a business," says Becker. "But when a business's revenue goes down, you can cut your product or service. In government, when times are bad everyone needs government services more."

Iowa recently answered that challenge with an executive order for 2.5 percent across the board cuts - but ran directly into its own "reinvention of government" act passed last session. The law exempted six departments (including human services and corrections) that make up a significant share of the budget.

Colorado has similarly had to steer around its K-12 education budget, constitutionally mandated to grow by 1 percent a year, plus inflation. "It is now clear to most that the boom of the 90s for states was a one-time anomaly related to capital gains from the stock market boom," says Nancy McCallin, state budget director for Colorado. "Now we are learning the hard lessons that we cannot rely on the way things were during that time."

With costs such as healthcare rising fast, many states face this sobering realization: The belt-tightening of recent years may become standard practice.

"States are doing interesting and creative things" to get by, says Scott Pattison, executive director of the National Association of State Budget Officers. The problem, he says, is that states "have not gone after those expenditures that will save them the multimillions they need."