How Sept. 11 Broke the States' Budgets

Sometimes, it's good to be the governor of Tennessee. This is not one of those times. Don Sundquist is in the final two years of his second term, when he should be looking forward to leaving office and relaxing. Instead, he’s spending much of it watching his state sink into a fiscal black hole. Earlier this year, the slowing economy shrank tax revenues and dug Tennessee a budget deficit of over half a billion dollars. The state barely balanced the books this summer and then terrorism struck and the economy took a nosedive. After reviewing the latest budget numbers last week, Sundquist told reporters, "Have you seen the movie ‘The Perfect Storm’ where everything converges to create a complete disaster? What I saw today was the perfect storm." He’s not exaggerating.

Make no mistake — the economy was already in trouble before Sept. 11th. Almost half the states faced budget shortfalls for 2001 or 2002. But after the attacks, the U.S. economy effectively took a vacation for the rest of September. Now 40 governors are facing fiscal crises and the boom times of the nineties, when state governments regularly handed out tax cuts and new social programs like candy, are a distant memory. Sundquist and the 39 other governors have to make some painful choices.

It’s unclear how the attacks will affect the economic picture in most states. But in some places it’s obvious. New York faces a very painful situation, and will need more federal help. States that depended on tourism dollars, like Florida, Hawaii and Nevada, are reeling as people cancel vacations and stay close to home. Washington state, where Boeing was already struggling before the airlines started begging for handouts, now has a $1 billion hole in its budget. California faces a triple blow. Its economy also depends on tourism, the energy crisis cost the state $6 billion, and the dot.com collapse in Silicon Valley sapped taxes on capital gains. And manufacturing states, like Ohio and Michigan, already hurt by the slowdown, are unsure when things will get better. The only states not confronting hard times are ones that rely heavily on energy industries — Texas, Alaska and eight others.

But states facing hard times now are in better shape than they were during the last recession a decade ago. Most states took advantage of the boom times to create rainy day funds, storing away the extra cash. "Most states were better prepared for this slowdown," says Scott Pattison, executive director at the National Association of State Budget Officers.

States got so attached to those reserve funds that now they don’t want to give the billion-dollar security blankets up. Most states are holding off from tapping those funds yet, because the attacks have made the long-term economic picture hard to predict. What if things don’t get better next year? Most governors and legislatures would rather make budget cuts or delay some of their tax cuts for now.

Of course, some states don’t have that option. Tennessee has no income tax and still relies on sales tax for most of its revenue. That revenue has been shrinking even during the good times. When times turned ugly earlier this year, Governor Sundquist lobbied the state legislature to finally pass an income tax. In June, legislators met to consider the idea. Anti-tax demonstrators surrounded the capital building, throwing rocks through the windows and banging on the doors. Not surprisingly, the lawmakers changed their minds. (Not many politicians work well surrounded by an angry mob.) They ended up using the state’s $560 million share of the national tobacco settlement to balance the books. But now things are worse. The shortfall has grown another $275 million, and some polls show Tennesseans are starting to think an income tax wouldn’t be such a bad idea.

Other states have more options, and they need to keep them all on the table for now. Things may get better next year, preventing further painful decisions, but they may not. Jeb Bush has called Florida’s legislature to Tallahassee for a special session starting next week and he’s negotiating with legislative leaders over which options will be on the table. They need to fill a $928 million hole in the budget. Bush has proposed using reserve fund money to pay for half of it and getting the rest from selective budget cuts. He’s also hinted he may delay a tax cut. But conservative House Speaker Tom Feeney wants across-the-board budget cuts instead. With the economic outlook so uncertain these days, it’s almost impossible to know what the right decision is.