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Fed cuts threaten state budgets


Potential federal budget cuts are a dangerous threat to state budgets that are already much more precarious than the public realizes, says a new report on state finances.

The State Budget Crisis Task Force, a group led by former Federal Reserve chairman Paul Volcker and former New York Lt. Gov. Richard Ravitch, spent the past year studying the budgets and finances of states, primarily six, including Virginia.

They found that most states are suffering from diminishing tax bases, increasing Medicaid costs, and are postponing payments to employee pension plans and critical infrastructure investments.

Those problems, the report says, are exacerbated by the recent recession but not solely caused by it, and states need to build better strategic plans to balance their budgets in the long term.

One of the biggest potential threats to shaky state finances is potential federal budget cuts.

Federal lawmakers have been pushing for debt and deficit reductions in recent years. But the discussion about federal spending rarely takes states’ needs into consideration, the report says.

Overall, 23 percent of states’ budgets comes from federal grants, and cuts could “wreak havoc” on states, the report says. That percentage is higher in states like Virginia, with a large presence of federal workers, contractors and installations.

A 10 percent cut in federal grants, the report said, would equal about $60 billion from states and would be equivalent to doubling the corporate income tax, slashing police and fire spending in half or completely eliminating spending on libraries and parks.

The report said that federal spending on procurement, salaries and other areas is 65 percent higher in Virginia than in the average state, and a five percent cut in those areas would lower spending in Virginia’s economy by $850 per person.

The report proposes that the federal government start considering how its actions will affect states.

“There is a ‘disconnect’ between the federal government and the states, with no formal mechanism for evaluating the impact of proposed federal policies on the states,” the report says. “There should be a permanent national-level body to consider the ways in which federal deficit reduction or major changes in the federal tax system will affect states and localities.”

Potential federal budget cuts are only one of the problems facing state budgets, however.

Medicaid costs are growing faster than the economy and faster than state tax revenues, and is starting to “crowd out” other spending needs. Medicaid costs are expected to only increase as the baby boomer generation ages and more people retire.

Tax bases are eroding and becoming less predictable. According to the report, personal and corporate income taxes and sales taxes made up about 38 percent of states’ tax revenues in 1950. Now, those areas make up 71 percent of states’ tax revenues. Yet those are the most volatile taxes because they are “increasingly dependent on financial markets.”

Shifts like online sales are also cutting into states’ tax revenues; currently, most states can’t or don’t tax online sales unless the online retailer has a physical presence in the state.

There is legislation in Congress to change that but it hasn’t passed at this time.

Many states—including Virginia—are also seeing increasing unfunded liabilities in their pension systems, exacerbated by years of refusing to fully fund their pension systems.

“Many pension plans with the greatest need for increased contributions have an additional burden in the fact that their states and localities habitually have skipped or underpaid their actuarially required contributions: That is, these governments have willfully underpaid and now find it difficult to afford the contributions required,” the report says.

Underfunding pension obligations is one of a number of budget “gimmicks” that states use to create budgets that are technically balanced, but in truth are not.

Virginia, for example, has in several years used a gimmick called the accelerated sales tax—forcing retailers to pre-pay a portion of a month’s sales tax at the end of the fiscal year, so that it goes onto the ending year’s books instead of the new fiscal year.

The report warned states against such accounting practices, as they make for less stable budgets.

“Falling revenues, rising spending, and budget gimmickry also conspire to destabilize the states’ finances,” the report said. “States that act in the full spirit of their balanced budget rules may slash spending, raise taxes dramatically, scale back care for the needy when they are most in need, increase class sizes when recessions hit only to reduce them in recovery, or raise, then lower, tax rates. These outcomes are undesirable as politics and as policy.”

According to the report, all of these problems are only going to get worse over time unless states take action to correct them. The purpose of the report, said its authors, is to raise awareness from the public about these state budget issues.

Chelyen Davis: 540/368-5028