Cities And States May Throw A Wrench Into The Recovery

Economists who are forecasting a ro bust recovery in the months ahead might do well to ponder the parlous fiscal condition of U. S. states and cities. Recent surveys show that 28 states and over half of the nation's cities are spending more than they take in. These include such headline-grabbers as California, which is facing a $ 13 billion in budget shortfalls, and New York State and New York City, which are attempting to close projected budget gaps of $6 billion and $ 3 billlion, respectively.

This trend isn't entirely new. According to the Commerce Dept., the combined balance of all state and local operating budgets, including capital outlays, has been sinking into the red since 1986. The situation deteriorated badly late last year, however, as the recession cut sharply into revenue growth and caused the deficit to balloon to a record $ 44 billion annual rate (chart).

The red ink in the mid-to-late 1980s marked the first time since the 1960s that state and local jurisdictions experienced worsening operating budget deficits during an economic expansion. In the 1960s, though, such deficits reflected rising investment in human and physical capital--education and infrastructure such as highways--which promised to enhance future productivity and revenues. By contrast, the fastest-growing spending in recent years has been for medicaid and correctional facilities.

With the recession in full swing, spending for welfare and unemployment compensation has also accelerated sharply. As a result, fiscal woes are growing, despite tax hikes totaling a record $10.3 billion passed by 26 states last year. Because almost all states and many cities are bound by balanced-budget requirements for their noncapital budgets, more tax hikes and spending cuts are inevitable. Planned layoffs at state levels already exceed 50,000.

Economist Joseph Carson of Chemical Bank notes that outlays by state and local governments adjusted for inflation actually rose by an average 5% during past recessions--mainly because rising federal grants offset sagging tax revenues. This time around, however, federal aid is being cut back, so real spending is headed down.

The upshot, says Carson, is that the current recession may prove more severe than many observers anticipate. Similarly, economist Maury N. Harris of PaineWebber Inc. believes that the combination of continuing state and local tax hikes and spending cuts is likely to make the coming recovery only about half as strong as previous upturns.

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