American States Going Bankrupt

As the federal deficit passes $1 trillion, 48 of the 50 American states have a cumulative deficit of $166 billion. California in particular is close to default.

Why not legalize and tax marijuana to combat the budget deficit? It is one of the latest ideas in California’s frantic race to find solutions for its $26.3 billion “gap.” A democrat who proposed a law to tax the plant, made popular by a recent publicity campaign, says such a tax could raise a billion dollars.

California, the state with the largest economy, has been in a state of semi-default since July 1. The local government has been constrained since issuing debt securities to repay its suppliers and the citizens holding its debt. As of this week, banks are no longer accepting the state’s bonds. The provisional budget deficit for the current year has reached a record high: 58 percent of the state’s revenues. As the crisis wears on and the deficit grows daily, the governor announced to the unions at the beginning of the week that the state must lay off 2,000 public employees to reduce its expenses.

Unlike the federal government, the U.S. Constitution forbids states from acting under deficit, with the exception of Vermont. It is therefore a strenuous exercise every year to find equilibrium between revenues and expenses. The problem is exacerbated in a recession: revenues fall, affecting the withholding taxes; consumption falls, diminishing the sales tax; companies provide fewer benefits. In all, 48 of 50 states are facing a deficit for the current year. On average, the deficit comes to 24 percent of revenues for the states. This represents a cumulative need for $166 billion of financing.

To get out of the red, some states will not raise taxes or cut social services. As they were unable to find a solution to their budget headache before July 1 as they were supposed to, no fewer than seven states – California, Arizona, Illinois, Ohio, Pennsylvania, Connecticut, and North Carolina – are again negotiating this week to adjust their budget, which is causing political tension.

Between governors and legislative assemblies, a tax increase maintains the budgetary deadlock. As of today, 30 states have chosen to raise their taxes and seven others are preparing to do so. Reduced at the federal level since the Reagan years, the tax burden has largely been transferred to the states, counties or cities. Every time an agreement on the budget is reached, however, the budget is quickly exceeded. In 12 states, the budgets adopted for the new fiscal year are already in the red. However, the states remain without the right to borrow to cover their operating expenses.

The Recovery Plan

“We have to go back to the Great Depression to see a worse time,” comments Sujit Canaga Retna, analyst and consultant for the Council of State Governments. Even if the economy takes off again, the budget crisis will endure. Between January 2009 and the end of 2011, the shortfall in tax revenues is estimated at $350 billion. In this context, the range of solutions is limited: draw on reserves, as was widely reported last year; reduce current expenditures; raise taxes, and create new sources of revenue, for example by creating casinos or lotteries.

No fewer than 39 states have already adopted cost-reducing measures. Most affected are education, healthcare and social services. “The most serious problem is that these cuts of public services are affecting the most vulnerable citizens at the moment when they have the most immediate need because of the recession. There is a risk of creating a vicious cycle, aggravating the current economic situation in the country,” worries Jon Shure, member of the center on Budget and Policy Priorities.

The Obama administration is coming to the rescue of the states in need through its $787 billion recovery plan, a part of which is reserved for the states. In theory, it will create employment through vast investment programs, but in reality, the federal money is being used to fill holes: it has only made it possible to make up 40 percent of the state budget deficits.