Sunday, August 30, 2009

State budgets continue to pose major risks to recovery

One of the biggest risks to sustainable economic recovery is often overlooked. It is the unprecedented budget shortfall faced by the majority of US states. Here is an updated map from the Center on Budget and Policy Priorities (CBPP) showing states that are or expected to be facing budget shortfalls.

Unlike the federal government however, most states' constitution prohibits them from running a deficit or borrowing to cover their operating expenses. States are faced with the following choices:

1. Draw down existing reserves,
2. Cut spending,
3. Raise taxes.

Those who can are now drawing on reserves, creating a temporary cushion. However the reality for 2010 and beyond is grim. Spending cuts across the board will negate some of the federal stimulus programs in place. But a larger risk to the economy will come from state tax increases. As we discussed before, the tax multiplier on the GDP is roughly 3. That means for every dollar in tax increases, the GDP is expected to contract by $3. And states have a great deal of ground to cover with a budget shortfall of $165 billion in 2010 and an estimated shortfall (from CBPP) of $180 billion in 2011. Below is the updated report from CBPP:

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