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Year ahead looms as toughest yet for state budgets

FILE - In this Jan. 10, 2011 file photo, California Gov. Jerry Brown points to a chart as he explains his approach to dealing with an estimated $25.4 billion state budget deficit during a news conference at the Capitol in Sacramento, Calif. California is just one of many states facing a year of reckoning as they deal with multi-billion dollar budget deficits. FILE - In this Jan. 10, 2011 file photo, California Gov. Jerry Brown points to a chart as he explains his approach to dealing with an estimated $25.4 billion state budget deficit during a news conference at the Capitol in Sacramento, Calif. California is just one of many states facing a year of reckoning as they deal with multi-billion dollar budget deficits. (AP Photo/Rich Pedroncelli, File)
By Judy Lin and Shannon McCaffrey
Associated Press / January 16, 2011

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SACRAMENTO, Calif.—If 2011 is hinting at a national recovery, there is little sign of it in statehouses across the country.

States that already have raided their reserve funds, relied on borrowing or accounting gimmicks, and imposed deep cuts on schools, parks and public transit systems no longer can protect key services in the face of another round of multibillion dollar deficits.

As governors roll out their budget proposals and legislatures convene this month, they do so amid a sputtering economic recovery and predictions of slow growth for years to come. State and local governments face lackluster revenue projections, worries from Wall Street over looming debt and the end of federal stimulus spending.

In the first weeks of 2011, Republican and Democratic governors alike have begun detailing across-the-board pain for education, health care, transportation, public safety and other programs. Some say the year of reckoning for state and local governments is at hand, with calls for structural changes that could radically shift expectations of what services government provides.

Many believe the months ahead will be the most challenging in memory, with consequences for millions who depend on government funding.

"We need to send a message to the governor: We're real, and we depend on all these services," said Sergio Garibay, a 41-year-old Southern California resident who relies on state disability payments and recently protested deep cuts to Medi-Cal programs proposed by California Gov. Jerry Brown. "There are other alternatives to the budget. Why don't we tax the rich, these corporations?"

In releasing his budget proposal, Brown told California lawmakers "the year ahead will demand courage and sacrifice" as the state faces a deficit projected to hit $25.4 billion over the next 18 months. His proposal combines spending cuts to Medi-Cal, in-home services for the elderly and higher education with a five-year extension of income, sales and vehicle taxes.

New York Gov. Andrew Cuomo proposed eliminating 20 percent of state agencies by combining duties, such as merging the Insurance Department, Banking Department and the Consumer Protection Board into the Department of Financial Regulation. It's part of "radical reform" to pull his state out of its fiscal crisis. And Gov. Chris Christie in New Jersey skipped a $3.1 billion payment to the state's pension system in a push to cut benefits for public workers, while proposing higher employee contributions and a boost in the retirement age from 62 to 65.

In Illinois, lawmakers voted for a dramatic 66 percent hike in personal income tax, from 3 percent to 5 percent, in a bid to resolve a $15 billion deficit, which amounts to more than half of the state's entire general fund. The tax increase will be coupled with strict 2 percent limits on spending growth.

"It's important for their state government not to be a fiscal basket case," Gov. Pat Quinn in defending the major tax hike.

And on and on it goes:

-- In oil-rich Texas, where education and social service spending is relatively low and Republican Gov. Rick Perry has railed against government spending, hard times are looming. The shortfall is projected to be between $15 billion and $27 billion over the coming two-year budget cycle.

-- In South Carolina, outgoing Gov. Mark Sanford has proposed a spending plan that would end funding for museum and arts programs, slash college funding and give many state employees a 5 percent pay cut.

-- In Georgia, deep cuts appear to await the state's popular HOPE scholarship program that provides public college tuition to students who earn good grades. Rising tuition and enrollment have outpaced the lottery revenues that fund the program and Gov. Nathan Deal has not proposed any additional state money to bail it out.

Even as tax revenue in many states shows signs of a rebound, states are expected to collect 6.5 percent less than they did in 2008, according to the National Association of State Budget Officers.

And any revenue gains could be more than offset by the expected loss of federal stimulus money. Most of the $814 billion stimulus program was designed to help states provide essential services and give a boost to the economy, but will start to run out this summer. A new round of stimulus funding is unlikely with Republicans controlling one house of Congress. Top GOP lawmakers say they will try to provide states with relief by reducing mandated programs, not by giving them more money.

"States came into this recession with relatively large rainy day funds. Now that states have done the accounting gimmicks and the relatively easier stuff, each year gets harder and harder because those one-time things are gone," said Nicholas Johnson, director of the state fiscal project at the Center for Budget and Policy Priorities, a think tank in Washington, D.C.

Despite lower tax revenue since the recession began, the level of service expected from state and local governments remains, often creating a disconnect between public perception and the reality of the fiscal crisis confronting elected officials.

Public schools face rising enrollments, more people are seeking government health care because they have lost jobs or their employers have dropped coverage, and millions of those thrown out of work are receiving unemployment checks.

One possible solution is revising tax structures, even with an anti-tax mood persisting across much of the nation.

In Georgia, some lawmakers are considering a 4 percent state sales tax on groceries and boosting the tax on cigarettes as part of an overhaul of the state's outdated tax code. The increases would be paired with reductions in the personal and corporate income taxes.

But any proposal for tax increases will run into opposition from Republicans, who were swept into office in large numbers last fall on a message of reducing the size and reach of government.

Republicans picked up 690 state legislative seats Nov. 2 -- the largest shift since 1966, according to data compiled by the national legislative group. The GOP now controls both chambers of the state legislature as well as the governorship in 21 states.

"When you've got an unemployment rate at 10 percent, I don't think that's a good time for us to tell Georgians that we need more of their money," Georgia House Speaker David Ralston said. "I'm going to resist that again this year."

As states struggle to balance their books, Wall Street is watching rising debt burdens, although analysts so far have not sounded many alarms. Federal law does not allow states to file for bankruptcy protection, but states can default on their debt if their financial condition worsens considerably.

That move is extremely rare. Arkansas was the last state to default on its debt payments, a move it took during the Great Depression. Moody's predicts that no state government will default on its debt in 2011.

Moody's Managing Director, Naomi Richman, said states generally borrow for long-term infrastructure projects. They don't usually borrow to pay debt and fund operating budgets. Those that have, including California, Illinois and Arizona, already have been penalized with low credit ratings, which increases their borrowing costs.

It's possible, however, that more cash-strapped cities and counties could seek bailouts from states, as Harrisburg sought help from the commonwealth of Pennsylvania.

"I think you're more likely to see it cascade up, rather than down," said Steve Malanga, a senior fellow at the Manhattan Institute, during a discussion about state budgets at George Mason University.

Kail Padgitt, an economist with the nonpartisan, nonprofit Tax Foundation, said the states with the greatest concerns about their fiscal health are those with costly public employee pensions that are underfunded.

Many public pension systems use overly optimistic rates of return and do not provide a true, long-term cost to taxpayers. Padgitt cited a recent study by the Pew Center on the States that found states face a $1 trillion funding shortfall in public-sector retirement benefits, but said that likely underestimate the problem.

"The long-term outlook is quite bad," Padgitt said unless states begin to make pension reforms.

Matt Hanson, 50, a civil engineer who has worked for California's transportation department for 22 years, said he understands that public pension systems could use adjustments but he believes pensions are fundamentally sound. For example, he said he's open to contributing more to cover retiree health care costs, which have been rising.

"If there's some shared pain that has to be felt than I want it to be constructive," Hanson said. "There's a difference between going out for a run and feeling pain right after -- at least you'll be in better shape in the long run, rather than hitting your hand with a hammer. Pain for pain's sake doesn't make a lot of sense."

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McCaffrey reported from Atlanta. Associated Press writer Robert Jablon in Los Angeles contributed to this report.