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US States Face Budgetary Black Hole

by Mike Godfrey, Tax-News.com, New York

02 December 2002


New York City may have grabbed the headlines last week for its swingeing property tax rise, which will reverse this year's fiscal deficit, and will take a bite out of next year's far worse $6.5bn budget hole; but it is just one of many cash-strapped US municipalities facing the need for urgent action to ward off looming insolvency.

Unlike the federal government, US states are constitutionally required to balance their budgets, and will have to choose between cutting expenses or raising taxes to deal with an expected total imbalance this year of more than $17bn. The problem results from enthusiastic spending increases stimulated by leaping tax revenues during the boom of the late 1990s - now tax receipts have fallen out of bed but the spending remains.

A report published last week by the National Governors' Association says that states cut their spending last year (ending 30th June) by $13bn despite having planned an increase of only 1.3% (down from 8.3% in 2001). Yet tax revenues and other state income actually fell by 6% last year, the first time since 1945 that income had failed to increase.

The reasons for the fall in tax revenues are well understood: the economic standstill, a fall in capital gains from equity assets, a structural shift in the economy from goods to services, and the growth in untaxed Internet sales among other factors. Some of the damage will be reversed when the economic cycle improves, but major change in the states' tax models seems inevitable.

Simply cutting back on expenses is not much of an option. Some recent spending programmes can probably be reversed, but most of the damage has been done by mandated spending programmes such as education and Medicaid, both of which have experienced spiralling costs which are largely out of the states' control.

This year will have to bring change. Either the federal government will have to intervene or taxes will have to rise. Given the Republican dominance of Congress and the administration's determination to cut taxes, Washington will probably have little choice but to involve itself in a restructuring of states' responsibilities. Whether the end result will be a reduction in services or an increase in taxes, it is too soon to judge. What is clear is that there is no politically popular way out of this mess.


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