US state finances

Financial Times
Thursday January 29, 2008 Pg 14

The most painful time to tighten your belt is just after gorging. US state and local government expenditure - 12 percent of gross domestic product - expanded by almost 8 per cent in the third quarter of 2007, year-on-year. Now governors across the country are proposing big budget cuts. New York City lasat week said it would cut spending on a range of services, from schools to sanitation, to offset slowing tax revenues - partly because of Wall Street's woes.

It is not merely the prospect of a recession that is forcing a rethink on spending, but the nature of the potential slowdown. State and local taxes, excluding transfers, split about 60-40 in favour of states. Typically state coffers are filled by taxes on sales, personal income and corporate profits. Local taxation, meanwhile, is overwhelmingly based on property - 72 per cent of total revenues, according to Moody's.

In 2001, the primary impact of the slowdown was on personal income tax. However, consumers kept spending and house prices kept climbing, underpinning sales and property taxes. The threat this time is spread further across the tax base, primarily because of the housing downturn - California, Florida and New York are among the largest states facing deficits. Although local officials may not be in such a rush to reassess home values now that they are falling, the secondary effects on sales and income taxes would bite earlier.

Moody's believes that states are better prepared this time round. However, the uncertain environment means local officials may have to react quickly - and with unpopular measures - if big gaps open up on their ledgers. It is worth remembering that state and local spending has increased by about $100bn a year over the past three years. If expenditure now stays flat, that will dampen a signficant portion of the $150bn federal stimulus package now being finalised in Washington.