Friday, July 25, 2008

WSJ: States Slammed by Tax Shortfalls

As we've been predicting for a long while.... I wrote in [Apr 25: Shoes Beginning to Fall in the States],

This is a theme I have been promoting for a while, and it's going to hit this year, next year, and 2010. Unlike the federal government who fixes all fiscal emergencies by simply printing money out of thin air or taking hat in hand to China, Middle East, or anyone who will buy our Treasuries, the states do not have that luxury.

I wrote in [Dec 16: California in a State of Emergency - Coming to a Theater Near You]

Here it begins folks.... as I stated in this week's piece [The Web of Credit Snares Another: Cleveland] One point I forgot to mention in the 2008 1st half predictions piece is the role of ever decreasing housing values on state (and city) revenue. A large part of revenue inflows is based on an asset (real estate) that is decreasing throughout the country. Budgets (and benefits) are set to recent 'good times'. Like most enterprises very few government institutions will save for coming rainy day times - they just assume the good times will continue to roll. But when they don't, they are in trouble. Especially if a very large revenue source starts to shrink (property taxes). And this should be happening over the next few years throughout the country.

What's the solution? Print more money. Wait. You can only do that at the federal government level. So I guess the solution is.... well, I don't know what the solution is.

I don't know when (or hey, even if) the equity markets will finally come to the realization of the scope of the coming damage, as the bond markets obviously have. But this is only 1 of many shoes. Again, do you expect home values to go up in 2008? How will California's 2009 budget look? In just over a month the projected shortfall in CA has risen from $10 billion to $14 billion. Give it another 12 months... as many people sitting on overinflated 'assets' are finally going to sell at 20-30% lower prices. Remember, new homes are being sold off at 40% off levels seen in 2006 as home builders desperate to get rid of inventory price at fair value....

Why do you care if you don't live in California? Well it will be hitting a lot of other states for one, and secondly eventually the "real economy" affects the market ... eventually... no matter how persistent the 'invisible hand' is in seeing that this not happen. I will repeat, by the time these political candidates get to their primaries the economy is going to be the 1st, 2nd, and 3rd issue. We're just getting started here.

Fiscal Emergency for California

So here we are - the new fiscal year begins in July 2008 and CNBC's long touted 2nd half 2008 recovery is upon us! Oops. Not so much. As tax revenue from both the home "fake boom" and consumer spending "fake boom" dwindle, state and local budgets are now becoming an issue. And we have not even faced the real "unemployment" depths that will be hitting within the next 12-18 months. Much like subprime was the leading edge of the mortgage crisis, I believe school budgets especially will be the canary in the coal mine and where the first stresses will become "major stories". Budget year summer 08 to summer 09 will be bad. Budget year summer 09 to summer 10 is going to make this year look like a picnic. Cover story of the Wall Street Journal earlier this week - States Slammed by Tax Shortfalls I'll call this the "Michigan-anding" of America. Everything in this article sounds so familiar...

Remember, unlike our friends in D.C. our local governments cannot just call up the local Helicopter (Ben) and ask for a money drop. Save for a rainy day during good times?! Never! That's Un-American!

From here...simple decisions need to be made ---> (a) cut services, jobs, benefits and/or (b) increase taxes. [Jul 2: Cook County, Chicago ---> Highest Taxes in the Nation: 10.25%]
  • The stumbling U.S. economy is forcing states to slash spending and cut jobs in order to close a projected $40 billion shortfall in the current fiscal year. -- identified Wednesday in a survey by the National Conference of State Legislatures --That gap is more than triple the size of the previous year's. (wait til next year)
  • It is the result of broad economic weakness at the state and local levels that could cause pain throughout this year and into 2010.
  • Sales-tax collections, for example, have been hurt by the housing slump and high gasoline prices, which are prompting cutbacks in consumer spending. Personal income-tax collections have been hit by rising unemployment, while corporate income-tax collections have been eroded by falling profits.
  • Unlike the federal government, most states are required to balance their budgets. (hah)
  • Most have so far resisted tax increases, instead opting for raising prices on things like tolls and college tuition, and cutting back on services like education and health care.
  • Some chose one-time measures such as tapping rainy-day funds that were built up in flusher times. That could lead to future cutbacks if the economy doesn't bounce back in coming months. (in that case count on future cutbacks)
  • The spreading economic weakness also is affecting localities, which are being ravaged by falling property-tax collections and a decline in state aid.
  • Several state-university systems are being forced to raise tuition and tighten their belts.
  • Regents at the University of California and California State University system have raised undergraduate fees 7.4% and 10% annually, respectively, to cope with rising enrollment and other costs. Virginia Tech is raising its tuition for in-state undergraduates by nearly 11% (this won't be found in your friendly CPI figure - move along, benign inflation in America - substitution effect will be in full force - everyone in America will be going to community college or better yet skipping college all together so we can keep the core CPI low)
  • States are also reducing their payrolls and programs. Vermont is cutting about 400 jobs through attrition, while Tennessee is using buyouts and possibly layoffs to eliminate about 3,000 government jobs.
  • Social services have been hit hard. Ten states have made targeted cuts in Medicaid, while three have cut contributions to the Temporary Assistance for Needy Families program. (that's ok, we have banks to bail out - don't worry about those people)
  • The housing slump, now well into its second year, is the primary culprit. The decline in home sales has cut into real-estate transfer taxes. Construction spending and employment have declined. Fewer home sales have resulted in lower sales of home furnishings and washing machines, eating into sales taxes. (I was told not to worry 18 months ago - after all housing is only 4.5% of GDP... hmm, darn CNBC)
  • Of course, for many states, today's budget woes stem at least partly from expanding their services during the good times and not planning enough for the inevitable downturn. Meantime, states are dealing with shortfalls of many kinds. According to the report by the association of state legislatures, 22 states are reporting sales taxes that are below forecast. Seventeen states had a shortfall in corporate income tax, 11 states were behind on personal-income taxes, and 11 were also behind on miscellaneous taxes such as insurance-premium taxes. (gosh and that is during "an economy that has hit a few minor roadblocks but is structrually sound" - just imagine if there was a recession)
  • At the same time, costs are rising. Over the past several years, many states have taken over more of their K-12 education funding from local governments, while many others have expanded Medicaid.
  • In Illinois, Gov. Rod Blagojevich unilaterally cut $1.4 billion from the $59 billion budget the legislature sent him in May. The state says it expects to save an additional $500 million through belt-tightening at state agencies. The governor's changes include heavy cuts in spending for education and health care. (aka non essentials)The state plans about $600 million in health-care cuts, including making hospitals and nursing homes wait longer for Medicaid reimbursements.
  • Health services, among states' fastest growing costs, are being cut across the country. Ohio is closing two mental-health facilities as state agencies look to shed $733 million. The state is also cutting a program that provides free nicotine patches to smokers. Virginia's funding for hospitals and nursing homes to care for the poor and elderly was reduced by $76 million over the next two fiscal years, according to an analysis by the Commonwealth Institute for Fiscal Analysis in Richmond, Va. Maine is cutting money for foster care, mental-health services and "flexible funding," which social workers can spend on specific needs for clients.
2008 2nd half recovery? Full steam ahead.

[Jul 14: Reviewing December 2007's Roadmap and Views]
[Jun 19: Tent Cities Sprout Up Across Southern California]
[May 7: Vallejo California Votes for Bankruptcy]

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