08/29/2011 12:50 pm ET | Updated Dec 21, 2011

Record State Budget Shortfalls Likely To Drag Down The Private Sector For Years

WASHINGTON -- While the current economic downturn is often referred to as the worst since the Great Depression, today's conditions are by some measures actually worse than they were during the depths of the 1930s. States are struggling to recover from the worst hit to their tax revenue in U.S. history. They have never before experienced a drop in tax revenue as steep as that of the past three years -- not even during the Great Depression.

With the federal government's economic stimulus money now gone and little political will in Washington to reopen the spigots, thousands of critical state and local government jobs -- from teaching to transportation -- remain are on the verge of elimination, along with other spending. And that's bad news for both the public and private sectors.

The Great Recession that began in December 2007 caused deep declines in state revenue, according to Federal Reserve data. States' personal income and corporate tax revenues took the sharpest dips.

According to data from the Bureau of Economic Analysis, analyzed by The Huffington Post and adjusted for inflation, states are now receiving less in receipts from all forms of state taxes than they were in 2005. There has been a 9 percent drop since the peak collection year of 2007 -- a decline of state revenue not seen in the post-WWII era.

The Center on Budget and Policy Priorities also found that states have faced record-level budget shortfalls in the past few years and those shortfalls are projected to continue for some years.

State budget woes decreased a bit in 2010, as money from President Barack Obama's economic stimulus package flowed from federal coffers. The states received $144 billion under the stimulus legislation, along with additional federal grants for food stamps, infrastructure and other direct programs. Despite criticism from political conservatives, this aid to states not only helped preserve jobs in teaching and other sectors supported by state and local governments; it also helped maintain jobs in the private sector, thereby boosting state tax revenues.

Because states are now entering fiscal 2012, the first year without stimulus funds to help cover their revenue shortfalls, and because states keep trying to close those shortfalls by cutting spending, the next year could prove to be more difficult -- for public and private sector workers.

"When states cut spending, they cancel contracts they have," said Mike Leechman, director of state fiscal research at the Center on Budget and Policy Priorities. "There are all kinds of connections between the public and private sector. We don't have two economies." There are direct linkages -- private-sector doctors rely heavily on government payments, for instance -- and less direct connections.

"[It could be] a paper supply company that gets a lot of its business from government. Or the restaurant across the street from the university where there have been layoffs. And so all these cuts that states have been making have really had a major impact," Leechman said.

Even as signs of a slow recovery begin to emerge, a lack of spending by states is holding the private sector down and helping keep the overall economy at a stand still.

The decline in state revenues actually started before the Great Recession officially began, with state income plunging as early as 2005 due to tax cuts enacted during the housing bubble. In 2006, home values began plummeting, bringing down property tax collections with them. As Wall Street shuddered, private employers responded with mass layoffs, savaging both income and sales tax revenue, leaving states with less money to deal with the crisis.

State & Local Tax Revenue

In response, state governments collectively have slashed nearly half a trillion dollars in the past five years, far more than what the stimulus sent to states. More than 500,000 public employees have been let go at the state level since August 2008.

"The layoffs the states have made and the other cuts have been a very serious drag on the economy," said Leechman. The spending cuts by states have made the recovery more difficult to sustain and, he said, have actually made the recession deeper.

"It's going to be years before states' revenue fully recover from the recession," Leechman adds. "The need is going to continue to be high for a while because unemployment continues to come down very slowly."

The continued fragility of state balance sheets this deep into the economic downturn indicates that further job losses are around the corner. Recent data from the U.S. Labor Department shows continued declines in government jobs in recent months, despite very modest gains in the private sector. Education employment is particularly depressed, even more so than during the the Reagan recession of the early 1980s.

In past economic downturns, state tax revenue (adjusted for inflation) typically continued to climb, even during the Great Depression. The biggest dip prior to the Great Recession was in the late 1970s.

State payrolls usually remain more resilient than those of the private sector during recessions, according to a recent paper from Lucy Dadayan and Robert B. Ward of the Rockefeller Institute. Declines in tax collections and increased enrollment in safety-net programs like Medicaid typically hit state budgets later in economic slumps, even as the economy may begin its recovery, according to Stateline, a division of the Pew Center on the States. Recessionary effects also continue to plague state and local governments longer than the federal government because they lack the federal government's borrowing authority. As for local tax revenues, Daniel Carroll at the Cleveland Federal Reserve said they have been taking longer to react to the recession, declining over the last nine months or so, mostly due to differences in tax bases.

Even Federal Reserve Chairman Ben Bernanke warned in a speech in March that states were going to struggle for a while.

The federal government itself is likely to deliver another blow to states, given the current Beltway fervor for spending cuts. That's a serious concern since money from the federal government makes up just over a quarter of total state revenues, said Carroll.

"[Congress] settled on a number for discretionary cuts, and to find those cuts out of the FBI or national medical research is very unlikely," Leechman said. "State aid accounts for a third of all nondiscretionary spending -- [it's] very unlikely states won't get hit there."

Dadayan concluded in her Rockefeller report, "If revenues falter again in a weakened economy, states' budgetary choices will grow even more difficult." Meaning more cuts to Medicaid and public universities, fewer contracts with private companies and more layoffs of teachers and other public employees.

Her colleague Ward said in an email to The Huffington Post that even if a particular state does not enact further cuts, the drop in tax revenue and less support from Washington will have a long-term impact on state and local government employment. There will be fewer new hires -- one more barrier for the nation's jobless trying to find work.