While states’ tax revenue is increasing, the weak economy is generating less revenue than before the 2008 financial collapse and associated recession, according to a new report, but the fundamental problem in spending and revenue shortfalls is structural, not cyclical.
For the report, the State Budget Crisis Task Force examined the financial condition of six heavily populated states (California, Illinois, New Jersey, New York, Texas and Virginia) to determine the threats to fiscal sustainability.
When an economy goes into a recession, state revenue decreases, while spending for Medicaid, the social safety net and higher education all increase.
And while the federal government’s automatic counter-cyclical stabilizers, such as unemployment compensation, start up against the recession, state budgets become procyclical. In a sense, state budgets act as headwinds against national economic recovery.
“This outcome is undesirable as politics and as policy,” the report stated.
The report found six major threats to states’ fiscal sustainability: growth in Medicaid spending, federal deficit reduction, underfunded retirement plans, eroding and volatile tax revenue, local government fiscal stress and state budget laws and practices.
In order to address the structural problems of state budgets, the Task Force called for, among other initiatives, a national body to evaluate the ways in which federal deficit reductions or changes in the federal tax system will affect states and localities.
“There is a ‘disconnect’ between the federal government and the states, with no formal mechanism for evaluating the impact of proposed federal policies on the states,” the report said.
In addition, The Financial Times reported, the Task Force said states should reform their tax structures, making them more stable and adaptable to modern spending trends.
“The existing trajectory of state spending, taxation and administrative practices cannot be sustained,” the report stated. “The basic problem is not cyclical. It is structural. The time to act is now.”
Many cities around the country are struggling to cover their expenses, as their economies try to recover from the massive housing downturn and recession, which have led to lower tax revenue for cities, according to CNNMoney. As a result, three cities in California have filed for bankruptcy protection in the past few weeks.
Eric Hoffman, an analyst at Moody’s, predicts more cities in California and throughout the country will file for bankruptcy.
Still, “we don’t expect it to be widespread,” he said.
In fact, Chris Hoene, research director at the National League of Cities, predicts that of the 19,000 city governments in the United States, the number of bankruptcies will be fewer than 100.
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