First, housing markets might be slow to fully recover; their decline already has depressed consumption and sales tax revenue as people refrain from buying furniture, appliances, construction materials, etc. This also would depress property tax revenues, increasing the likelihood that local governments will look to states to help address the squeeze on local and education budgets. And as the employment situation continues to deteriorate, income tax revenues will weaken further and there will be further downward pressure on sales tax revenues as consumers are reluctant or unable to spend.
Unlike the federal government, the vast majority of states are governed under rules that prohibit them from running a deficit or borrowing to cover their operating expenses. As a result, states have three primary actions they can take during a fiscal crisis: draw down available reserves, cut spending, and raise taxes. States already have begun drawing down reserves; the remaining reserves are not sufficient to allow states to weather the remainder of the recession. The other alternatives — spending cuts and tax increases — can further slow a state’s economy during a downturn which produces a cumulative negative impact on a national recovery as well.
The combination of Federal budget issues and State budget deficits could have a significant impact on any future economic recovery, especially if spending cuts and tax increases are enacted. The budget issues facing the various states bearing watching as it could be the fly in the oinment to a sustained economic recovery.
Below is a list of the top 20 states with the highest budget gaps as a percentage of the state's respective budget. Of course California is in a dire fiscal situation; but there are many states facing large budget deficits - all on the list have deficits in the billions of dollars. (Click on chart for full size)
