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There were no surprises, only confirmations, in the report released on Friday by the Center on Budget and Policy Priorities (CBPP): “States Continue to Feel Recession’s Impact.” As author Elizabeth McNichol stated, governors “across the country…face a daunting fiscal challenge. The worst since the 1930s has caused the steepest decline in state tax receipts on record. State tax collections…are now 12 percent below pre-recession levels.”

There are 44 states estimating budgetary shortfalls for next year (most states’ fiscal years start on July 1) totaling, preliminarily, more than $125 billion. And waning federal assistance granted under the American Recovery and Reinvestment Act (ARRA) is making it more difficult for governors to close the gap. Plus, the recently enacted Bush tax cut extension allows companies to speed up depreciation of new equipment, further reducing state revenues. In addition, the House has plans to reduce further various grants that states have been factoring into their budgets for years. In other words, fiscal 2012 is the year when the chickens come home to roost.

Most states have undertaken austerity measures through services while increasing taxes (some by calling them fees, which don’t require taxpayer approval—e.g., Colorado). And stop-gap measures, such as raiding “rainy day” funds and other reserves, are no longer available. Even those states in relatively good shape—New Mexico, Alaska, and Montana—face challenges in keeping their budgets from going into the red.

The one option few are willing to talk about, however, is state bankruptcy. Much has been written about cities, townships, and municipalities considering bankruptcy as a way out of their difficulties. Bankruptcy gives the city breathing room, and leverage, to deal with intransigent and unhappy bondholders. But, according to the New York Times, since states are sovereign, bankruptcy is not an option. And so quiet efforts have started to do a “work-around” so that when the first state comes to Washington for a bailout, the feds will have something to offer instead of another bailout. Such an arrangement would give the states leverage in dealing with state workers’ and teachers’ unions.

The are ready. Charles M. Loveless, legislative director of the American Federation of State, County and Municipal Employees, said the states “are readying a massive assault on us. We’re taking this very seriously.”

Municipal bondholders aren’t waiting around. In just the last two months, $25 billion has been withdrawn from municipal bond funds, and the flow is accelerating. That’s one of the reasons why current negotiations are being kept low profile. If bondholders smell any kind of panic, justified or not, major withdrawals could result in much lower bond prices in that relatively illiquid market. And the consequent rise in interest rates which would be demanded to offset the additional perceived risk will just make it more costly for states who aren’t so close to the edge financially to continue financing their operations.

David Skeel, a professor at the University of Pennsylvaniawrote in The Weekly Standard an article that attracted so much attention—“I have never had anything I’ve written get as much attention as that piece”—that Skeel has even had private conversations with both Republicans and Democrats about his suggested strategies, although he declined to name the individuals. The appeal of Skeel’s proposal is that it gives Congress an “out” when the governors come begging.

While there is much to criticize in these suggestions, and much time before any proposed legislation sees the light of day, these efforts illustrate once again that the states are running out of options, just as the federal government itself is.

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