While states can expect to receive more than $150 billion through fiscal 2011 from the economic stimulus package, they still will face severe budget gaps for at least a year after that until tax revenues return to pre-recession levels, according to a new report by the Rockefeller Institute of Government.
"Even under optimistic assumptions, the revenue recovery will not be sharp enough or soon enough to avoid the need for significant budget cuts or tax increases," said the report, which was authored by Don Boyd, a senior fellow at the institute.
The funds provided by the stimulus package will come close to filling the budget gaps this fiscal year and next, but the gaps will grow larger in fiscal 2011 and on.
The report uses the past three recessions in 2001, 1990, and 1981 as a basis for making projections about this one.
It considers two scenarios for states: a "low gap," under which the current fiscal crisis will be a bit less severe but longer than the one in 2001, and a "high gap," under which the fiscal downturn will be worse and last longer.
"Under any likely scenario, states will face significant budget problems when the new federal aid runs out," the report said. After the last two recessions, it took at least five years for tax revenue to return to its pre-recession peak, the report said.
In a low-gap scenario, if the tax revenue falloff and recovery are similar to the fiscal crisis in 1990, states could face a fiscal gap of 4% of general expenditures, roughly comparable to gaps of more than $70 billion annually, when the stimulus aid starts to go away in 2011 and 2012.
The high-gap assumption suggests that states could face a 2011 fiscal gap of more than 6% of state general expenditures, or more than $120 billion annually.
Under the milder scenario, income taxes would decline by 10% during the first calendar quarter of 2009 and by 15% during the second quarter.
Sales tax revenues would decline by 3% on average in each of the final two quarters of 2009 and by another 3% in 2010 under the low-gap estimates.
"In subsequent years, tax revenue is assumed to recover more slowly than in the 2001 crisis because of the deeper and longer recession," the report said.
However, under the high-gap scenario, the income tax would decline by 20% in the first calendar quarter of 2009 and by 25% in the second quarter, suggesting the "worst declines in capital gains [taxes] in the 50 years of recorded history," the report said. The sales tax declines of the fourth quarter of 2008 would worsen by about 10% in the first two quarters of 2009.
Income and sales taxes would then decline further in fiscal 2010, making it the worst two-year period by far in more than 50 years, the report said.
Tax revenue would begin to recover in fiscal 2011 as the recovery takes hold, but sales taxes in particular would grow relatively slowly during the recovery as consumers work to restore savings and assets after massive losses in their stock market holdings and home values, the report said.
Still, budget gaps in fiscal 2012 will likely rival the critical shortfalls that states faced before enactment of the new stimulus package, the report concludes.
"Cuts or reductions in the growth of spending on education, health care, and other programs, and/or major tax and other revenue increases, will almost certainly be on the table once again," it said.
Because of this, states should use the "breathing room" provided by the stimulus package to spread out spending cuts and-or tax increases that they will need to make and to restructure programs, the report said.