Yes, revenues are going up, but my guess is actual state spending is not.

In other words, the rate of state ‘borrowing to spend’ including capital budgets has likely slowed?

That’s a net drop in aggregate demand- higher taxes without that much higher spending.

Also, spending federal funds is already figured in aggregate demand calculations as part of federal deficit spending.

And states are still struggling with the likes of pension contributions which decrease aggregate demand as well.

So looks to me states remain a net negative for growth next year, though as credits things are probably a lot less bleak than recent headlines have suggested.

As previously discussed, federal deficit spending floats all boats, etc.

States Begin Slow Recovery as Revenues Increase


State and local budgets are in far better shape than a year ago as receipts from sales tax and corporate taxes pick up, but pressures remain from pension costs and Medicaid commitments.
By JAMES C. COOPER, The Fiscal Times

• Total state and local receipts, excluding federal grants, are up $120 billion..
• 42 states show increased tax revenues compared to a year ago.
• There were 72 municipal bond defaults in 2010, down 65 percent from 2009.

The poor condition of state and local budgets is on everyone’s radar, but just how much should we worry? Wall Street analyst Meredith Whitney recently declared on CBS’s 60 Minutes that, next to housing, the situation was the single biggest threat to the U.S. economy. That may have been true a year ago, when the recession had ravaged tax receipts and a lasting economic recovery was still in doubt. However, recent trends in both revenues and the economy look much more encouraging, and the risk of major short-term economic damage appears to be waning, not waxing.
Budget problems are not going to disappear anytime soon as states face the burden of huge unfunded pension obligations and rising Medicaid costs, among other expenses. California, for one, has a $28 billion deficit this year. The state received $630 million of stimulus funds for job creation, but according to the L.A. Times, only 25% of those funds have been spent due to bureaucratic red tape.
But governments are making significant progress, as many start to feel the updraft from the economic recovery. Tax receipts of state and local governments rose 5.1 percent in the third quarter from the same quarter a year ago, based on the latest accounting from the Bureau of Economic Analysis. Personal income taxes have yet to show much progress amid slow job growth, but sales tax receipts picked up notably last quarter, reflecting improving retail sales. The lion’s share of the growth in revenues has come from corporate taxes, which have surged 87 percent over the past year, as a result of this year’s surprisingly strong gain in corporate profits.
One often-cited problem for many states in the coming year is the expected loss of some $40 billion in federal money provided by the 2009 Recovery Act. However, many governments stand ready to make up the difference. State and local revenues from individual and corporate income taxes and sales taxes in the third quarter were up by $54 billion from a year ago, a growth rate that is likely to pick up in 2011, as economic growth and labor markets strengthen. In fact, since hitting bottom in the second quarter of 2009, total receipts from all sources, excluding federal grants-in-aid, have increased by $120 billion and have recovered all of their recession losses.

Analysts at the Rockefeller Institute noted a “significant improvement” in the state revenue picture and that the trend in tax collections for 2011 is “positive.” Based on their preliminary tracking for the third quarter, 42 states show an increase in revenues compared to a year earlier. However, individual stress levels vary greatly. Overall, the Rockefeller analysts say budget pressures remain, and additional revenue growth will be needed at a time when spending commitments continue to grow.
More revenue may well be the key surprise in the coming year. Revenue projections for the 2011 fiscal year, which began for most states on July 1, were based partly on economic forecasts at that time. Six months ago, the economy was slowing down as the European debt crisis sparked fears of a double-dip recession, and economists widely projected growth only in the 2-2.5 percent range for 2011. Now, given the rebound in consumer spending in the second half of 2010 and significant new stimulus in the recent tax deal, which offers a big boost to household incomes, a broad brush of economists have raised their 2011 growth projections into the 3.5-4 percent range. If realized, that pace and its implied boost to payrolls would greatly lift receipts from income, profits, and sales taxes, which make up 46 percent of state revenues, compared to 34 percent from federal grants.
State budgets may actually fair better than local finances next year. That reflects the different sources of revenues between states and cities. Property taxes account for 35 percent of local government receipts, while grants-in-aid from their respective state governments make up another 40 percent. The problem: Property taxes fluctuate with assessments, which are bound to go nowhere in the coming year, and many states under continued stress will find it difficult to funnel money to municipalities. Clearly, the better state coffers do in 2011, the better the condition of local budgets.
All this raises fears of a rash of defaults in the $2.8-trillion municipal bond market, as the 60-minutes report suggested. States and cities under the heaviest fiscal stress are already paying a significant premium on new borrowing, and the loss of Build America Bonds at the end of 2010, part of the 2009 Recovery Act, could lift borrowing costs further.
However, muni-bond defaults have actually fallen in 2010, to 72 totaling $2.5 billion, down from 204 in 2009, according to data reported by Bloomberg. Chris Hoene, director of research and innovation at the National League of Cities, notes that interest expense is only about 5 percent of state and local expenditures, and nearly all debt is long-term with predictable payments. Plus, almost all states and cities have balanced-budget requirements with provisions to address debt issues before default can occur.
Unfortunately, the draconian cuts already seen in state and local services and jobs have been the chief reason defaults have been held in check. For 2011, however, fewer cutbacks and a smaller hit to the overall economy seem likely. Economists at Barclays Capital project further declines in state and local payrolls of about 150,000 by the end of 2011. Every job is important, but in the big picture, that’s a drop in the bucket. Moody’s Analytics estimates that, if the economy grows nearly 4 percent next year, it will create about 2.6 million jobs, each one adding new revenues to state and local coffers. The same Barclays analysis projects that state and local governments will subtract only about 0.1 percentage point from growth in GDP in 2011.
State and local budgets are by no means out of the woods. Pressure will most likely continue into 2012, and longer-term problems loom with rising pension costs and Medicaid commitments. For now, at least, governments are making progress, and a stronger economy will add to the positive trend.

14 Responses

  1. Tell me why this is wrong: Normal inflation makes it impossible for the states to survive long term on taxes alone. They all need money coming in from outside their borders, either through exports, tourism or federal support. But, of course, all states cannot be net exporters, so regularly increasing federal support is necessary. In this, the states are identical with the PIIGS.

    Rodger Malcolm Mitchell

  2. First, agreed. That’s what I meant by “federal support.”

    Second, visualize a State as a closed system. There is a set number of dollars in the State, and there is inflation.

    The State does not have the power to print money, so where will additional dollars come from to pay for inflation-priced goods and services?

    Answer: Net exports, tourism and federal spending, which long-term evolves solely to federal spending.

    1. if it’s a closed system, the money the state pays for goods and services at higher prices is there to be collected as taxes.

      it’s only transfers to other sectors outside the closed system that are your issue.

      1. Say, in this closed system, the State has 1 billion dollars within its borders. It needs to spend 1 billion dollars this year, so it taxes the people 1 billion dollars, then spends the money in the state.

        At the end of the year, the people have their 1 billion dollars back. No problem.

        The next year inflation forces the state to spend 1.1 billion dollars on the same goods and services. Where do the additional dollars come from? Unless the State levies taxes twice, it only can tax 1 billion dollars that year.

        It probably will have to borrow, pushing 100 million in needed taxes to the following year. But the following year will have its own problems.

        The following year, inflation forces the state to spend $1.2 billion, and on and on and on. Velocity can’t make up for the lack of dollars in the state.

        This is the problem all monetarily non-sovereign governments have. Being unable to create “dollars”, they are limited to a fixed number of “dollars” of depreciating value.

        Of course the U.S. states are not closed systems, so they must deal with the massive outflow of dollars for FICA and income taxes, which the federal government should return, plus inflation. Unfortunately, there isn’t enough “plus” from the federal government

        Rodger Malcolm Mitchell

      2. Yes, the state can do it in two stages, or quarterly, or continuously.

        Once it spends 100 million the funds are there to pay the taxes that you’ve established.

        And the idea that there is ‘1 billion dollars within its boarders’ isn’t a real world assumption, as how do you define those dollars?
        Actual cash and the state can only spend actual cash? checking accounts, in banks where loans create deposits? etc?
        Anything beyond ‘actual cash’- the world of ‘loans create deposits- doesn’t necessarily have the liquidity constraints you are concerned about.

      3. Rodger,

        Isn’t the state that you describe a closed economy by definition? If so, where in the world does that 10% inflation come from?

        Don’t disagree with your point re regressing to a sovereign issuer. But a state dependent on tourism, exports, and a federal govt is by definition an open economy…

  3. govt deficit spending supplies the net financial assets to the states and the rest of the non govt sectors.

    So should Cullen have limited govt sector to federal govt?

    “The deficit of the entire government (federal, state, and local) is everywhere and always equal (by definition) to the current account deficit plus the private sector balance (the excess of private saving over investment).”

    1. he is correct as stated.

      deficit spending by state govs adds net financial assets (the states bonds and other iou’s) to the other sectors

      and, anticipating your next question,
      the net financial assets of the state govt and state private sector combined don’t go up with state deficit spending if that spending stays in the state. All that happens is the state gov’s nfa go down and the state’s private sector nfa’s go up

  4. Warren, no matter how you define it, the number of existing and potential dollars within the borders of a monetarily non-sovereign state either is infinite or limited. I vote for limited. These limited real and potential dollars lose value every year due to inflation.

    So, the total buying ability of the state (people + government) is reduced every year.

    By contrast, the number of real and potential dollars in a Monetarily Sovereign state is infinite.


    1. ” the number of existing and potential dollars within the borders of a monetarily non-sovereign state either is infinite or limited. I vote for limited. These limited real and potential dollars lose value every year due to inflation. So, the total buying ability of the state (people + government) is reduced every year.”

      Or not. Deflation can occur too. Are you assuming that inflation is a constant? Certainly not happening in Europe’s periphery at the moment. Our “strong dollar” policy deflated the hell out of many countries that had adopted non-sovereignty in the 1990s. Plenty of other examples.

      As above, while there are many non-monetarily sovereign entities, there are very few closed economies in the world (and fewer every year). And I disagree that sovereign issuers are “always and everywhere” inflationary (if that’s what you’re saying).

    2. Yeah, I agree with Rodger. The distinction is often made between the federal govt and everyone else, including states*. It makes sense to put the NFA-creating federal govt in its own sector.

      *“Moreover firms, households, and even state and local governments require income or borrowings in order to spend. The federa government’s spending is not constrained by
      revenues or borrowing”,<
      Galbraith, Mosler, Wray, “Protecting the Budget from Intergenerational Warriors”).

      I think every state but Vermont (who does it anyway) has a balanced budget requirement in their constitution, so it should net out the same in terms of operational budgets. On the other hand, states pay for infrastructure via capital budgeting, Uncle Sam does not. That is to say, if a state water authority builds a dam, construction cost is charged off off over the life of the structure. If the Army Corps of Engineers builds a dam, the entire cost is booked the year of construction.

      To that end, creating a federal capital budget isn’t the worst idea in the world. If we have to spend $2 trillion on deferred infrastructure and the average useful life of project is 20 years, easier pill for Congress to swallow if the infrastructure is scored on the budget as $100 billion a year for 20 years versus $2 trillion on this year’s budget.

  5. Art, I used “closed economy” to simplify the example. No state actually is “closed.” Many states are “negative economies,” where more export, tourist and federal tax money flows out than flows in.

    And yes, deflation can occur, though inflation is far more common.

    Americans tend to think their financially strapped states were managed poorly. While that may be the case, I was trying to show why long-term, it is impossible for any monetarily non-sovereign government to survive on internal tax money alone. They all need money flowing in, and ultimately the federal government must spend significantly more dollars in each state than it removes via federal taxing.

    Rodger Malcolm Mitchell

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