Don't go overboard with cuts

By Jon Shure

Like most states, Pennsylvania and New Jersey will soon ring in a new year not with champagne and noisemakers, but with recession-battered financial plans that threaten the well-being of families and could further impede economic recovery.

The states' fiscal years begin tomorrow, and the budgets taking effect that day - or, in Pennsylvania's case, whenever lawmakers and the governor manage to agree on one - will be grimly austere. That's the result of perhaps the most daunting set of financial challenges since the Great Depression, which are likely to last through 2011.

The problem is the ripple effect of a national recession: People buy less and earn less, reducing what states get from income, sales, and corporate taxes, their main funding sources. Sadly, the current revenue declines are the largest in memory, while the need for the services the money pays for is rising dramatically.

Unlike the federal government, states can't print money or run deficits. So to meet today's needs and emerge strong when prosperity returns, they should use a balanced approach. Rather than tipping the balance too much toward cutting spending, they should also responsibly raise revenues and make the most of federal stimulus funds. By supporting income-tax increases, Govs. Rendell and Corzine are following the advisable game plan.

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Those who argue for a cuts-only approach ignore the reality that spending reductions in Pennsylvania and New Jersey are already expected to go way beyond the budgetary "fat," carving into muscle and bone. Examples include halving support for at-risk kindergartners in Pennsylvania and slashing $100 million of nursing-home funding in New Jersey.

Cutting can be counterproductive. State budgets are dominated by spending on health and education - areas essential not only to residents' day-to-day well-being, but also to producing a skilled, healthy workforce and a strong economy down the road.

Besides the obvious impact on people's lives of cutting too deeply, there is the harm it can do to a state's economy. Consider that state spending goes mostly for salaries, contracts, purchasing, and financial assistance to people in need. That's economic stimulus - money spent quickly and close to home. Turning off that tap slows demand, making recessions worse.

To avoid a dangerous overreliance on spending cuts, more than half the states have raised taxes this year, or are considering doing so. History tells us that's prudent. Raising taxes does less harm to the economy than cutting spending does.

While big cuts take money out of circulation, at least some portion of tax increases - especially on the wealthiest households - comes from money that's parked in savings and isn't boosting economic activity. Past experience shows that the economic performance of states that raise taxes will be just as strong as those that don't - and, sometimes, even stronger.

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The third leg of the stool needed to support upcoming state budgets is money from the federal stimulus package enacted in February. Of the $787 billion in the stimulus bill, some $140 billion will go to states over the next two years to help them avoid or at least lessen reductions of important services. It was never expected to be enough to prevent all budget cuts or tax increases, but it will, on average, close about 40 percent of the states' shortfalls.

One of the main things the federal money should help states buy is time. Many states went into this recession with their finances already weakened by ill-advised tax cuts in the 1990s and a failure to keep pace with rising needs in such areas as transportation infrastructure, environmental protection, and health care. It would be a good idea to use the bit of breathing space offered by the federal stimulus to better align revenue systems with public priorities.

The depressing reality is that, though the national economy seems to show tentative signs of rebounding, state budgets will likely be under significant pressure for at least the next two years. State tax revenues tend to recover more slowly than the economy as a whole, because unemployment eases only gradually. And the hole from which states must dig out this time is as deep as they come.

A new year with the word happy in front of it is still far off for the states. But making the right decisions now will help.