California Revenue Recovery Shows State Cash Collapse Bottoming

The two-year slide in tax collections that opened a $196 billion gap in U.S. state budgets has stopped, easing pressure on credit ratings and giving leeway to lawmakers as they craft spending plans for next year.

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The 15 largest states by population forecast a 3.9 percent gain in tax revenue in fiscal 2011, budget documents show. The 50 states on average may increase collections by about 3.5 percent, the first time in two years the figure is expected to grow, said Mark Zandi, chief economist at Moody’s,

California took in 3.9 percent more since December than projected in January, Controller John Chiang said this month. New York got $129 million above forecasts in its budget year through February, according to a report from Comptroller Thomas DiNapoli. In New Jersey, the second-wealthiest state per capita, January sales-tax collections were 1.9 percent higher than a year earlier, the first annual increase in 19 months, forecasters said in a report last month.

“This time last year, we were sliding down a mountain,” said David Rosen, chief budget officer for the New Jersey Legislature. “I don’t think we are now; it’s stabilized.”

States collected almost $81 billion less in sales, income and corporate taxes in 2009 than in 2008, according to the Nelson A. Rockefeller Institute of Government in Albany, New York, as the economy struggled through its deepest slump since the Great Depression. Emergency spending cuts and tax increases became routine during the recession that began in December 2007.

‘Panic Mode’

The end of the collections crash will ease fiscal strains that led New York-based Moody’s Investors Service to lower the ratings of five states last year, after no downgrades in 2008. It will also enable governors and legislators to draw up budgets for fiscal 2011, which starts July 1 for most states, with more confidence that money they plan to spend will arrive.

“As long as revenues were sliding, budgeters were in a panic mode,” said Zandi, whose West Chester, Pennsylvania-based company provides economic analysis to businesses, government and investors. “It’s not as scary when revenues are rising.”

States’ combined budget gaps will still total $180 billion in fiscal 2011 and $120 billion in fiscal 2012, the Washington- based Center on Budget and Policy Priorities estimates.

This fiscal year, the 15 largest states expect to collect 11 percent less taxes than in fiscal 2008, budget proposals show. It won’t be until 2013 that revenue returns to 2008 levels, said New Jersey’s Rosen and Barry Boardman, the North Carolina General Assembly’s chief economist.

Economic Growth

State coffers are beginning to get a boost from an economy that expanded at a 5.6 percent annual rate in the fourth quarter of 2009, the most in six years. That’s stopped the drop in sales tax collections, which generated $18.4 billion less last year than in 2008, according to the Rockefeller Institute.

Company tax collections in the fourth quarter of 2009 were 5.8 percent behind a year earlier, after annual declines of more than 20 percent in three of the previous four quarters. They dropped 21 percent in the fiscal year ended June 30, the Census Bureau said this month.

Arizona, which sold state buildings and canceled health insurance for 47,000 children as collections this fiscal year fell 34 percent below 2007 levels, said corporate tax receipts exceeded budget projections by $23.8 million in January. Total revenue exceeded forecasts for the first time since March 2007.

Predictability a ‘Positive’

Virginia recorded a 31.6 percent increase in corporate taxes through February, it said on March 11. Governor Robert McDonnell, a Republican who took office in January, increased this year’s revenue projections by $82.5 million last month.

Improved revenues may help states replenish reserves, curb borrowing for expenses and strengthen their debt ratings, said Robin Prunty, credit analyst for Standard & Poor’s in New York.

“Just having predictability is a positive from a credit standpoint,” Prunty said.

“We’ve seen the worst,” said Philip Condon, who oversees about $9.4 billion in municipal bonds for DWS Investments in Boston. “While it may not be great, it’s getting better.”

DWS was among the buyers of last week’s $3.4 billion issuance of taxable California bonds, its first such sale since November. A scarcity of municipal debt, coupled with indications that California’s revenue decline may have reached bottom, attracted investors and drove down bond yields, Condon said.

“The recent uptick in revenue collections certainly didn’t hurt us,” said Tom Dresslar, a spokesman for Treasurer Bill Lockyer in Sacramento.

Spending Cuts

Forty-five states reduced outlays for health care, the elderly and disabled and primary and higher education in 2008 and 2009, the Center on Budget and Policy Priorities said.

Lawmakers now may be able to restore spending or avoid further reductions. California’s Chiang this month scrapped a plan to delay tax refunds after revenue exceeded projections for three months. In January, an impasse over the state’s $20 billion budget imbalance led S&P to cut its credit rating to A-, the lowest of any state.

“The fact that revenues are performing better I think is certainly the first bit of good news we’ve heard in a long time,” said Amy Doppelt, a San Francisco-based managing director at Fitch Ratings who follows California. Fitch last year downgraded more than 200 municipal issuers, the most ever, according to a March 25 report from the rating company.

Negative Outlook

S&P lowered its rating on California, Illinois and Arizona last year and has a negative outlook on those and four other states. Moody’s cut those three plus Nevada and Ohio, its first state downgrades since Michigan in 2007. It’s negative on 15, including five of the 10 largest: Florida, Illinois, Pennsylvania, Ohio and Michigan.

Jobless rates in 18 states including Florida and Rhode Island exceeded the national average of 9.7 percent in February. Unemployment in most states is about double pre-recession levels, according to the Labor Department.

Michigan, with the nation’s highest unemployment rate at 14.1 percent in February, is in its 10th year of job losses and expects to end fiscal 2011 with the fewest jobs in 24 years.

“As the employment situation continues to be weak, income tax revenues will continue to lag,” the Center on Budget and Policy Priorities said in a Feb. 25 report.

As workers lose income, states face rising expenses for Medicaid and other social services. Through March, they had borrowed $37 billion from the federal government to cover unemployment benefits, the Treasury Department said.

Pension Expenses

States face a $1 trillion gap between assets in public pension plans and their obligations to retirees, a Feb. 18 study by the Washington-based Pew Center on the States said. Illinois borrowed $3.5 billion in January to finance its pension contribution, which led Moody’s and S&P to cut their ratings to the second-lowest of any state.

“You can’t exclude the expense side,” said Howard Cure, New York-based director of municipal research for Evercore Wealth Management LLC, which oversees $1.7 billion, half in fixed-income municipals. “What really would alleviate that situation is more jobs.”

States also have to prepare for the June 2011 end of help from the American Recovery and Reinvestment Act, which will provide them with about $140 billion of aid since its inception in February 2009.

“States may have reached the end of the beginning of a multiyear fiscal crisis,” the Rockefeller Institute said in a January report. “The best to be hoped for in 2010 may be the beginning of the end.”

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