2011 Will be Rough Budget Year for States

State eNews Issue #44 | April 15, 2010

State revenues are down while the demand for services is up—leaving states in a very precarious position as they tackle their 2011 fiscal year budgets. The upcoming fiscal year will be “the most difficult to date,” according to a survey by the National Governors Association.

Most states had budget shortfalls in the 2010 fiscal year and a majority of states face budget gaps for the 2011 fiscal year, which for 48 states begins July 1. Budget gaps for the 2010 and 2011 fiscal years may hit $375 billion, according to the Center on Budget and Policy Priorities. To balance their budgets, states have few options, including spending cuts, increasing revenue (including tax increases) or a combination of the two approaches.

Thirty states raised taxes over the past two years, including increases in personal income taxes, sales taxes, business taxes, tobacco and alcohol taxes, and motor vehicle taxes and fees. Some states are even taxing soda and candy, according to a Stateline.org article.

“States are in dire need of revenue,” Sujit CanagaRetna, senior fiscal analyst with The Council of State Governments’ Southern office, the Southern Legislative Conference, told Stateline.org.  

State revenues are impacted not just by the recession but also by the shift to a service-based economy and the rise of e-commerce. Two-thirds of consumer spending is now related to services, which is not captured by outdated state tax structures that continue to primarily focus on taxing goods.

“We have a 21st century economy with a 20th century tax infrastructure,” CanagaRetna said.

Several governors—including Jennifer Granholm of Michigan—are now encouraging serious discussions about making the move to tax a wider range of services. 

“The governor has proposed a set of structural tax reforms designed to better reflect the new realities of the contemporary economy,” said Liz Boyd, Granholm’s press secretary.  

Those reforms include a more comprehensive approach to taxing services, thereby broadening the tax base and lowering the overall sales tax rate by 0.5 percent, which are included in Granholm’s 2011 executive budget recommendations now being reviewed by the legislature. Over the past 60 years, Michigan residents increased spending on services by 26 percent; 40 percent of all spending in 1950 by Michigan residents was spent on services. That jumped to 66 percent in 2010. This year, Michigan faces its lowest revenue levels in 45 years.

In 2006, New Jersey expanded its sales tax to include services like tanning and tattooing, increasing the state’s revenue receipts by more than $400 million every year since enactment, according to Stateline.org.

Although some states are raising taxes and fees to collect more revenues, states still have to make cuts to balance budgets. According to the National Association of State Budget Officers, state general fund expenditures dropped 3.4 percent in 2009 and will likely fall another 5.4 percent in 2010. This is in sharp contrast to the annual increases in spending of 6 percent or more that states regularly implemented throughout the 1980s, 1990s and early 2000s. Over the last two years, at least 43 states have cut services.

“Most states have had to cut their spending back to 2005-06 levels—which is a pretty radical transformation. In addition, while spending is down, the need for state services and funding is up, putting a tremendous strain on state budgets,” said CanagaRetna.

The American Recovery and Reinvestment Act helped states forgo some cuts, but much of that assistance will end in the upcoming fiscal year. Approximately $140 billion was funneled to states through the stimulus, which, according to the Center on Budget and Policy Priorities, helped plug 30 to 40 percent of state budget gaps in 2009 and 2010, but will offset less than 20 percent of those shortfalls in the upcoming fiscal year, potentially leading to even more extreme cuts.

In some states, the thorny budget process is putting a strain on the relationship between the executive and legislative branches. In Minnesota, a dispute over how much power the governor can exercise to eliminate or reduce funding already approved by the legislature has made its way to the state’s Supreme Court. The court’s decision could permanently change the budget-making process in the state.

A constitutional amendment has been proposed in Wisconsin that would prevent the governor from altering expenditures on individual spending items—effectively diminishing the governor’s veto powers.

While the situation may appear grim, there are some glimmers of hope on the horizon; February 2010 saw an increase in private sector employment for 23 states, according to a U.S. Congress Joint Economic Committee report. Because state recoveries tend to lag a national recovery, however, states will continue to face a challenging fiscal situation in the near future—forcing state leaders to seriously re-examine revenue strategies and spending patterns.

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