A grim forecast: the fiscal crisis slamming states won't be letting up soon.

• Author: Smith, Edward

Rising unemployment, dropping income tax revenue, the ongoing foreclosure debacle and a deep crisis in consumer confidence leave states facing the worst fiscal crisis in more than 50 years.

The double whammy of a drop in sales and income tax revenues means most states will limp through the remainder of this fiscal year and into the next. "It's probably a perfect storm for states," says economist Donald J. Boyd, a senior fellow at the Nelson A. Rockefeller Institute of Government who tracks state budgets.

A survey of all the states and Puerto Rico by the National Conference of State Legislatures released in December came up with sobering figures that could easily worsen as the recession continues to unfold.

"I think this recession will be worse than 2001 and likely the worst since World War II," says William T. Pound, executive director of NCSL. "States are now the primary financial and administrative support for health and education in ways that were not true of the past. The effect of a significant downturn in state revenues will be more broadly felt."

States are facing a $137-billion budget shortfall for fiscal years 2009 and 2010. Thirty-one states and Puerto Rico had to close a $40-billion shortfall when they approved budgets for the current year, which for most states started July 1. In addition, 38 states and Puerto Rico have reported that an additional $32-billion shortfall has developed in the last several months.

"This sum is expected to grow as states get updated revenue and expenditure reports," the study says.

Even grimmer news comes in projections for FY 2010. Based on estimates from 26 states--other states were unable to make projections at the point the survey was taken--officials are anticipating a $65 billion shortfall for that year and most think that number will increase.

"This recession is just getting to the worst part," David Wyss, chief economist for Standard & Poor's, said in December. "We think the fourth quarter of 2008 and the first of next year will be the worst. By mid-year next year we expect the economy to pick up.

"But it could be worse than that. This could still end up being a mega-recession."

DROPPING REVENUE

The current downturn particularly hurts states because of where they draw most of their revenue and where they spend the money. States are required to balance the budget each year, unlike the federal government, which can run a deficit.

A sharp downturn in personal, capital gains, sales and corporate taxes is ganging up on states. For the 41 states with personal income taxes, rising unemployment and plummeting capital gains will be especially painful this time, as it was in 2001.

"If you had to point to a single reason why the last fiscal crisis was so bad," it was the drop in capital gains, Boyd says. "It appears it's going to happen again. But given how steep the drop was last time, it's a little hard to imagine they will fall quite so sharply this time."

The collapse of the financial markets is drying up those capital gains revenues, reducing income from state investments, and in some states, such as New York and Delaware, leading to big job losses among high-income people.

"The people who are losing their jobs in the financial sector in New York on average make four times what people make in other sections of the economy," Boyd says.

Massachusetts Senator Steven Panagiotakos, chairman of the Ways and Means Committee, says his state was hit hard by the drop in capital gains in the 2001 recession, and things are not shaping up well this time, either.

"During our last recession, we saw a 70 percent decrease in capital gains," he says. "Right now our budget gap reflects a 30 percent decrease. Most of us believe that number will be significantly higher and result in a much bigger gap."

The NCSL survey reported personal income tax...