Page last updated at 11:29 GMT, Thursday, 2 July 2009 12:29 UK

US states face budget meltdowns

By Steve Schifferes
Economics reporter, BBC News

Fireworks at the Arch, St Louis, Missouri
Fireworks traditionally mark US Independence Day

Fourth of July celebrations will take place across US cities and states on Saturday to celebrate American independence day. But they are likely to be subdued, with many cities cutting back or eliminating the elaborate firework displays that have been a key feature of the celebrations.

It is the latest sign of the fiscal crisis that is spreading across the nation as the recession has had a dramatic effect on state spending.

The state of California, with a GDP larger than most countries, has been among the hardest hit.

On Wednesday, it said it would start issuing IOUs rather than cash payments to its creditors after the state legislature failed to agree a budget deal.

State spending

The 50 US states play a much more important role in the US system than local authorities do in a European context. Together they make up about one-third of all public spending, or 10% of US GDP.

Two early arrivals ring the bell at the front entrance to Guyton School in Detroit on Wednesday, April 8, 2009
Detroit is to close 23 schools and lay off 600 teachers.

Most spending on schools, roads and welfare support is made at the state level.

And the states also have an important constraint that the Federal government does not - they have nearly all passed laws in the past 20 years requiring them to have a balanced budget, and forbidding them to borrow money to pay for current spending.

This has hit them very hard as the US recession starts to bite.

States rely on sales taxes and property taxes at the local level to fund much of their spending.

These revenues have plunged as the economy has gone into freefall.

At the same time, they have faced higher bills to pay for the casualties of the recession.

California dreaming

California, the biggest and richest state in the US, has been particularly hard-hit.

It has an unemployment rate of 11.5%, well above the US average, and has been at the centre of the sub-prime mortgage crisis, with more properties foreclosed than in any other state.

Several of its biggest banks, including IndyMac, have been taken over by the federal government, and its manufacturing sector has been hard-hit by the crisis.

It also has more poor people and immigrants than other states.

So California faces a $26bn (£15bn) deficit on its general budget of $96bn.

But it is not alone.

According to the Center for Budget and Policy Priorities (CBPP), a Washington think tank, 48 of the 50 states are facing budget deficits this year, with a total deficit of $166bn, or 24% of their budgets. And it projects an aggregate deficit of $311bn by 2011.

Political deadlock

With the new fiscal year for most states beginning on 1 July, their state legislatures have been under pressure to agree and package of higher taxes and fees, and cuts in services to balance their budgets.

People protest outside the state Capitol as California lawmakers debated the budget
Some state workers have already seen their pay and hours cut

Seven states have failed to reach agreement on a new budget - including many of the big industrial states such as Illinois, Ohio, and Pennsylvania, as well as Arizona, also hard-hit by the sub-prime crisis.

They are being forced to resort to measures such as asking banks to loan state workers their wages (in Pennsylvania) to a one-week temporary spending bill (in Ohio).

The political deadlock is not surprising. Few legislators would like to raise taxes in the recession, rejecting, for example, Arizona governor Jan Brewer's request for a temporary increase in the state sales tax.

But about half of all states have raised taxes or increased fees already this year, according to research by the CBPP, while 12 are considering such measures.

The peculiarities of California's political system have made the deadlock particularly difficult to break in that state.

Passing a budget bill requires a two-thirds majority. But any compromise has been made more difficult because boundary changes have given most legislators in California safe seats with little chance of being unseated in an election - thus entrenching traditional party positions.

So far California Democrats have rejected the deep cuts in services and "revenue enhancements" (higher taxes) proposed by Republican governor Arnold Schwarzenegger and suggested $11bn in cuts instead, a plan the governor says he will veto.

And California voters rejected all the options for raising more revenue put to them in a recent referendum.

Impact on recession

But with no budget agreement, many states will have no choice but to reduce services and lay off government employees, as well as playing for time with temporary fixes.

California Governor Arnold Schwarzenegger holds a news conference on 1 December
Mr Schwarzenegger is struggling to solve California's budget

Already there is evidence from across the country suggest that services are being cancelled, from ending the summer school programmes for 14,000 children in Brevard County, Florida, to closing state parks in California, to reductions in eligibility for health care coverage in New York.

In California, its budget woes mean that:

  • Hundreds of infrastructure projects - road repairs, water maintenance, etc - have been shelved, along with the thousands of jobs they promised
  • counties and state suppliers have not been paid for services they provide
  • thousands of Californians who were looking forward to tax refunds, have not received them and will not do so in the foreseeable future
  • 20,000 state workers may be laid off and many more will be required to take unpaid leave

The reductions in state spending will also have a negative effect on the economy, deepening the recession in states where the cuts are most severe.

It was concern about such economic effects that led the Obama administration to include substantial aid to state budgets in its $787bn fiscal stimulus plan that was passed by Congress in February.

But relatively little of the promised money has arrived yet, and meanwhile the speed and scale of the downturn has made their fiscal position much worse.

According to Todd Haggerty, an analyst with the National Conference of State Legislatures, there have not been so many states without budgets since 2003, another recession year.

The schools superintendent in Brevard County, Florida, Richard DiPatri said he had no choice but to cut the summer school programme despite its academic benefits.

"Last year in Florida, our funding just went off the cliff," Mr DiPatri told the New York Times.

With many economists predicting that any recovery in the US economy will be weak and slow, the budget woes and political problems of the states are likely to continue for some time.

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