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States Discover Miracle Deficit Cure: Growth

Daniel Gross
Fin - Daniel Gross - US

In state houses and city halls across the country, deficits are all the rage. (In the case of Wisconsin, they're literally all the rage.) And many have been hoping that a miracle would spare them the tough choices required to produce balanced budgets.

Confronted with a tide of red ink, state and local governments, which are generally precluded from running deficits, have been raising taxes, cutting spending and firing workers. That's helping making the current expansion a "conservative recovery." The private sector creates jobs while the public sector cuts them, and austerity in states and cities counteracts the stimulus coming from Washington. By pushing them to cut services and jobs, and to raise taxes, deficits have made life miserable for governors, legislators, and mayors of every party.

Well, the miracle cure for deficits may be arriving: growth. Unsatisfying as it is, the current economic expansion is now midway through its eighth quarter. Tax receipts slumped sharply during the recession, and were slow to bounce back in 2009. But once the economic gears start to kick in, tax revenues can rise sharply. That's finally happening. With 1.3 million more people on payrolls in April 2011 than in April 2010, payroll and income tax receipts are rising. Corporate income has rebounded smartly. In the February-April 2011 period, retail sales were up 8.1 percent from the February-April 2010 period. That means more sales tax receipts.

States tend to draw their budgets and projected receipts based on the results of recent years. After a few good years, they tend to extrapolate the rising trend into the future. That sets them up for a crushing disappointment when the economy shrinks, which is what happened in 2009 and 2010. After a couple of bad years, states tend to project more modest growth of a lower baseline. And that sets them up for what stock analysts would call "upside surprises" — which is what is happening now.

Take California. Despite repeated rounds of deep budget cuts, slow growth and a deep unwillingness to raise taxes have left the Golden State chronically short of funds. And like his predecessor, Arnold Schwarzenegger, current-Governor Jerry Brown entered office facing extremely difficult decisions on how to narrow a deficit that topped $26 billion. Now, his task isn't looking quite so difficult. As the Los Angeles Times reported earlier this week: "State officials are reporting an unexpected $2-billion surge in tax receipts that will help lawmakers close the remaining $15-billion budget deficit, and the Capitol is humming with hope that more is coming." The New York Times reported on Monday that "California is now expected to see $6.6 billion more in revenue over the next two years than had been expected." There's still plenty of work to be done to close a deficit pegged at about $10.8 billion deficit, but higher tax payments will make it much easier.

In Connecticut, higher income and sales taxes have similarly improved the fiscal picture for Democratic Gov. Dan Malloy, who is engaged in tough negotiations with state workers over pensions. As the Connecticut Mirror reported in late April, projections for the state's general-fund surplus in the current fiscal year had been raised from $158.3 million to $458.1 million, thanks largely to higher revenues. In addition, "the revenue estimates for the next fiscal year are up by $282 million."

In Pennsylvania, with two months left to go in the current fiscal year, state revenue is running $506 million ahead of projections. As Pennlive.com reports "All three of the state's revenue streams — the sales tax, personal income tax and corporate tax — all produced more revenue than was estimated" in April.

This is happening across the board, according to a report from the Nelson A. Rockefeller Institute of Government in Albany. In the fourth quarter of 2010, total state tax revenues rose 7.8 percent from the fourth quarter of 2009 — the fourth straight quarter of growth. In the fourth quarter, nine states reported double-digit increases in revenues. The trend is continuing in 2011. Data from January and February show that: "Overall collections in 45 early-reporting states showed growth of 9.5 percent compared to the same months of 2010."

At the Federal level, the same dynamic is happening — but with an important caveat. Through the first seven months of fiscal 2011, receipts were $1.3 trillion, up 9.4 percent from $1.2 trillion in the first seven months of 2010. (Note the tally is still significantly below the total for the first seven months of fiscal 2008: $1.55 trillion.) In April, the federal government took in $289 billion in revenues, up from $245 billion in April 2010. The Office of Management and Budget estimated last year that federal tax receipts would rise just .6 percent in fiscal 2011. Now it's looking more like an increase of 9 or 10 percent. But thanks to rising spending, the higher revenues won't make much of a dent in the deficit. As a result, Washington has some extremely difficult and unpopular choices to make about taxing and spending in the coming years.

State governors won't be spared from these challenges. Better-than-expected revenues will only help close a portion of the large deficits that most face. But after years of negative shocks, rising tax receipts are providing a rare pleasant surprise. Just as a rising tide lifts all boats, a rising tide of revenues lifts the political fortunes of all incumbents. In the period of 2008-2010, being a governor was a tough, often thankless job. Today, life is getting easier for many governors.

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His most recent book is Dumb Money: How Our Greatest Financial Minds Bankrupted the Nation.