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Where Budget Constraints Actually Bind

January 31st, 2009 . by economistmom

Almost all state governments don’t have the luxury that the federal government has of being able to continually live beyond its means.  Take California’s situation, which is particularly strained.  From a CNN-Money story (emphasis added):

Suffering from both a $15 billion budget deficit and a multi-million dollar cash shortfall, California is days away from not having enough money to cover all of its bills.

Starting on Sunday, state controller John Chiang plans to delay sending state tax refund checks, payments to contractors and disbursements to counties and agencies that provide social services. He estimates that the state will be at least $346 million short in February.

“Rather than helping stimulate the economy, withholding money from Californians will prolong our pain and delay our economic recovery,” he said. “Individuals who already are vulnerable will be hit hard.”

Gov. Arnold Schwarzenegger and legislative leaders are behind closed doors trying to hammer out a solution to the state’s mid-year budget crisis and a projected $25 billion gap for 2009-2010. The governor has proposed draconian spending cuts in virtually every department, as well as hefty tax increases, to close the widest deficit in its history.

California is not alone in its budget troubles. Some 46 states face budget shortfalls, forcing them to slash funding for many services. But California is the largest state in the union, and its problems are particularly severe. Its deficit totals more than 35% of its general fund…

The state’s fiscal troubles largely stem from its heavy reliance on personal income taxes. This revenue stream dries up when recessions hit and unemployment soars. California also never fully recovered from the dot-com bust earlier this decade, which led to big budget problems at the time. So the state didn’t have large reserves to fall back on when the bottom fell out of the economy…

On top of its economic troubles, the state is also coping with a near shutdown of the nation’s government bond markets, which had allowed it to borrow to cover its short-term debts. This fall, the state was only able to borrow half of what it needed to see it through the fiscal year.

The lack of access to the bond markets prompted the state in December to suspend funding for more than 2,000 infrastructure projects, leaving many people and businesses without much-needed work.

And because of California’s financial woes, credit rating agencies are taking a dim view of the state. Moody’s warned in mid-January it might downgrade California’s general obligation bond rating because of its budget and liquidity problems. If this happens, it will become even costlier for California to borrow

Some relief may be coming California’s way. The state stands to receive billions from the $819 billion stimulus package that just passed the U.S. House of Representatives.

The state could get as much as $63.4 billion, some 12.3% of which could be used to balance the budget, according to the Center for American Progress. Some $3.6 billion could go for highway construction and transit improvements, restarting some of the projects currently idling. California will also receive billions to pay for education, Medicaid and other benefits.

Schwarzenegger, however, says the state must still work out its own budget problems.

“I always make it clear that we will not use that money to bail us out, because we have to bail ourselves out,” he said in a speech this week. “I think we have to be careful not to look at them [the federal government] as the savior, but to just look at them as the icing on the cake.”

Note that California’s budget woes are just a smaller version of the federal situation.  They’re forced to live by balanced budget rules, so the federal government–without such constraints–can bail them out.  And the federal government should help the states during a time when being forced to run balanced budgets is dangerous for the short-term economy.  But this means the debt isn’t paid down, it’s just shifted.  And even if California (like other states) intends to (or must) eventually “work out its own budget problems” and get back to living within its means, what will force the federal government to work out its own problems, if constraints will still not bind as we emerge on the other side of this recession?  Who will bail out the federal government–besides those foreign investors whose governments are now trying to get them to stop saving so much of their money?

One Response to “Where Budget Constraints Actually Bind”

  1. comment number 1 by: Imee

    well now that’s something to think about. i think people’s priorities are a little out of perspective at the moment.