The State and Local Hole

Although you may pay more taxes to the federal government, there is a good chance that the public services you are more likely to actually encounter in your life are provided by state or local governments – schools, swimming pools, police, fire, etc. While a lot of attention has focused on the federal government’s deficit problems, the problem for state and local governments, which generally have less fiscal flexibility (and cannot print money) is at least equally serious.

Here is the projected aggregate state/local government budget gap under two scenarios. First the “low gap” (optimistic) picture:


And here’s the high-gap (pessimistic) scenario:


The charts are from a presentation by Don Boyd of the Rockefeller Institute at the Chicago Fed. The space between the solid blue and dashed green lines is the impact of federal aid to states in the most recent stimulus package.

Update: Some readers asked for state-by-state information. You can find that here courtesy of the Center on Budget and Policy Priorities.

By James Kwak

34 thoughts on “The State and Local Hole

  1. Obviously the federal government needs to use its power of taxation to fill those holes, since the states lack that power themselves.

  2. I don’t feel like state and local government officials get it. One town in Mass is about to build the most expensive high school in state history, another is adding an addition on to it’s library, a third is buying new police cars. They cut budgets in areas that don’t matter but continue to spend as if they had all the money in the world. And, despite the fact that housing values have plummeted, my town just raised property taxes. Moreover, town officials refuse to disclose exactly how property taxes are calculated. I’m not sure the states and towns lack power, I think they abuse it.

  3. So .. if there is a 6% shortfall in revenue, state/local governments reduce their spending by that much and their budgets balance. What’s the problem?

    When you are paying City Manager and County Executives over $200K a year, they have to know how to cut back 5-10%.

    Most governments still don’t have much “yen” for automation, Information Technology, or e-Government. Their general premise is that government is a “jobs-for-life”, wealth redistribution engine.

    There is little evidence that this so-called “stimulus” has helped very much so far. In my town, stimulus money is being spent on “special education” at the local school district. Yes, there are other projects planed too, but it is very difficult to believe that many out-of-work laborers are going to be hired to work with “skills deficient” kids. (Bye-Bye Stimulus dollars and results.)

    Most state/local governments seem to be more like deer mesmerized by on-coming headlights than people who are nimble and prepared to play the hand dealt them.

  4. Couldn’t we outsource city management to India? I’d like to try it in our town. My hunch is that they couldn’t do any worse.

  5. Good stuff Mr. Kwak. You have some numbers that could break it down, state by state deficits??? Of course Everybody knows Cali is bad. Curious which states (if any) managed to break even. Maybe the other states could try to follow their example.

  6. I wonder as well which states are doing relatively well. Where I am, NJ, is in bad shape, heading in Cali’s direction: deeply in debt, saddled with a politically-driven “entitlements” crisis of its own.

    One thing I sort of assume but have not confirmed: does the stimulus reinforce the pattern by which the sap states like NJ pay out to the federal government far more than they get back (and therefore a graph like the above for just these states would look worse than the aggregate), while parasites like Alaska and the Southwest get big handouts?

    I picture the stimulus distribution being like that for “Homeland Security” money, where e.g. Wyoming was getting alot more per capita than NY.

  7. A few states were running budget surpluses (at least until recently) e.g. North Dakota, Wyoming – but not many. There are a couple things to keep in mind when concerns about state deficits and the system of taxation are mentioned.
    First, a large component of any municipal budget is determined by state and Federal mandates – especially but not exclusively in education. Over the last 30 years since Regan – Federal support for education has declined precipitiously so expenses once reimbursed by the Federal government through the state no longer are. Few municipalities have income taxes so they are dependent on property tax, service taxes, and transfers from state government.
    Property taxes have always been an unstable an inequitable way of funding local government. In New England generally, it pits de-industrialized cities and towns(with a de-valued built environment) against wealthy suburbs. Of course, now suburbs are learning the hard way that property values do not inexorably rise.
    But there is a profound irony to Americans propensity to complain about taxes. Objectively, the U.S. has a lower aggregate tax burden than most other OECD countries but hatred of taxes is perpetually vocalized, and the source of social mobilization. The birth of the Republic can be understood at one level, as a bunch of ingrates who didn’t want to pay for the military protection from ingigenes and French by the crown, and Americans have been bitterly opposed to paying for the critical service that only government can effectively (and equitably) provide. The anti-government rhetoric of the Regan era is now coming back to haunt us.

  8. D. Christopher Leonard, that is a jewel of a comment. Thanks so much for taking the time to write it.

  9. Look on the bright side. It’s probably the only effective check on the encroaching police state with their militarized gumshoes driving armored cars, playing at SWAT, tasing everybody in sight, and mandating CALEA support for unlawful surveillance. Collapse is looking pretty good right now.

  10. What is hilarious (in the hollow laughter, ha-ha sense) is how awful modern high schools are. Compare and contrast the public schools build pre-WWII with the insecticide factories we’ve built since then. We build schools that look like mental institutions or low security prisons and wonder why students don’t take them seriously.

    I’m sure the money will be spend on soon-to-be obsolete technology that will embarrass anyone who bothers to look at it again in a decade.


  11. Mr. Leonard,

    I think you mean the anti-tax rhetoric of The Founding is now coming back to haunt us?


  12. “I don’t feel like state and local government officials get it. One town in Mass is about to build the most expensive high school in state history, another is adding an addition on to it’s library…”

    I also live in a town in Mass. Not sure about Susan’s town, but in my town, capital projects such as these are being funded by debt exclusion override votes – votes by the town’s citizens. The citizens, not the officials, decide whether or not to raise their taxes to pay for these projects.

    “Moreover, town officials refuse to disclose exactly how property taxes are calculated.”

    Property in Mass. is to be assessed at full market value, by law. The rules that limit tax rate increases (Prop 2 1/2) are readily available on the State’s web site.

  13. Here is one way to handle a budget shortfall:

    Budget for outcomes, cut low priority stuff.
    The “no government” libertarian types discount the price of government and that government services have value. The big government liberal types overestimate the value of government services.
    Across the board budget cuts punish efficient government service, since the inefficient ones can withstand more cuts. Instead whole programs that fall outside the core mission should be cut completely.

    State governments face a death spiral: if/when they cut services, they also cut jobs and fees that provide revenue (fees for services like permits, parks, etc., and jobs mean tax revenue either through income or sales), which causes more cuts, etc.
    I read somewhere (I don’t have time to find the link right now) that CA sales tax revenue for 1Q’09 was down y/y 60%! Its only a matter of time before States and Cities start cutting jobs is really large numbers.

  14. Quick question on this – why aren’t property taxes being re-assessed as the housing market plummets? My town has hasn’t adjusted in 3 years – it doesn’t reflect what’s happening in the market. Please explain.

  15. You say: “despite the fact that housing values have plummeted, my town just raised property taxes.”

    Perhaps there’s a connection? When values drop, rates must rise to keep revenue stable.

    Meanwhile, you should come to California. Construction projects at public universities shut down in January, and have not restarted. Pay cuts and layoffs for all public workers, whether workgin directly for the state or for agencies, counties and cities, are nearly universal. California’s dysfunctional political system has gotten us there first, but if Republican tax-cutting obsessions continue to hold sway, other public entities will be in the same boat before too long.

  16. Wayne Martin: “So .. if there is a 6% shortfall in revenue, state/local governments reduce their spending by that much and their budgets balance. What’s the problem?”

    The problem, if there is one, would be a recession. In that case the gov’t should normally reduce its revenues further or increase its spending, or both. That means that it should be setting aside provisions for a rainy day. The larger problem is that it does not do that. The conservatives lower taxes, even in flush times, and the liberals spend all the time. (And the current Republicans do both, it turns out. :() For reference, see the Biblical story of the seven fat years and the seven lean years.

  17. Many of you just don’t get it.

    The raising of progressive State taxes often results in less State revenue, not more! Every Fed tax cut since the 60’s raised total revenue, not less. Most states are definitely on the downhill side of the Laffer Tax Curve, and cannot afford to raise taxes in this ugly recession. Plus, raising taxes destroys many of the business you need to keep people employed.

    The reason for this tax situation are many; here are some:

    A. People have choices. That terrible thing Freedom, has done it to us again! Drat! People can and often do move to lower tax states when taxes are raised. The Tax Foundation has a study out that reports that 1100 people a day on average for last 11 years left the high tax states for the low tax states. And these are your productive people, those who make a state go.

    B. Again Choices. Many high tax states have very progressive State Income taxes. When taxes get too high, high income people can opt for things like tax free bonds or less risky and financially rewarding investments. These choices take their toll of State Revenue.

    C. Higher Taxes depress business activity. Less business, less profits and in the case of this recession, perhaps no profits. Less or no profits mean less tax revenue, often a lot less because people can be pushed into lower brackets.

    As for the Feds, the total Income Tax take has consistently hovered around 19% since WWII, whether or not taxes were high or low. It’s post war high was during the height of the unsustainable dot com stock bubble ( 23%), and the post war low (prior to this recession ) was just two years later (16%) during the dot com bust under the same tax structure. Generally speaking, booms generate lots of taxes, while recessions cause tax revenue to fall, sometimes as now, precipitously.

    Therefore, the smartest way to maximize tax revenue is to generate sustainable booms. The tried and true method of creating booms is through reasonable regulation, free trade and low taxes. ( the 20’s. 60’s, 80’s, 90’s 2003-2007.) High taxes, trade restrictions and unreasonable regulation, on the other hand, historically cause recessions ( 30’s and 70’s) and considerably less total revenue.

  18. I think a major problem revolves around the duplication of services and poor coordination between federal, state, county and local entities with respect to services.

    In Westchester, Suffolk, Nassau Counties in New York, I suspect you could eliminate the county level of government ($1b) and no one would notice. Any shortfall, could be made up with the consolidation of services at the state level.

    By political leadership playing shell and blame games with the federal, state, county, and local jurisdictions, it is difficult for the voter to undersatnd what tax dollar pays for what service. And therefore, the taxpayer has trouble understanding what politicians are accountable for what spending.

  19. In many areas, the county budget is about 60% funded by real property taxes. With foreclosures galore, and assessments (tax basis) dwindling because of massive value declines, these governments will be hard pressed, and will be prime candidates for more bailout funds. Much of their budgets are tied up in schools, police and fire departments. A very large problem looming as new budget years approach in July.

  20. Of course, reduce taxes, why didn’t I think of that.

    Reducing taxes will also lower crime rates. Reducing taxes will reduce teenage pregnancies. Reducing taxes will help us win the war on terror. Reducing taxes will help everyone lose weight…

  21. Missing from Paul’s argument (infra) is the recognition that pitting localities, regions, and states against each other for the lowest tax burden is a race to the bottom. I take it he is about to move to Mississippi-worst health outcomes, lowest educational attainment, etc in the U.S? The logical outcome of the argument is to relocate to a low-tax nation state. Perhaps rural Burma (pardon Mynmar) beckons?
    I think there is a problem with the seemingly endless replication of levels of government. But aggregating the provision of services (police, fire, education, healthcare) argues for a regional approach and counties would seem to be the logical unit. In the east, counties have become less meaningful as administrative entities. In the west, they;re quite important and, I think may provide a national model.
    Another irony is that when states encourage (or mandate) the consolidation of service – such as regionalizing education, towns go up in arms, claiming it as a ‘loss of local control'(at least here in MA). So people complain about the costs of government and then proceed to protest against measures that might at least, manage costs.

  22. Not the school Susan is talking about.

    Newton North–also known as “Versailles High”–is the most expensive high school ever built in Massachusetts, a budget-busting $200 million Graham Gund-designed folly featuring a zig-zag footprint, glass-walled cafeteria, state-of-the-art student theater, and so on. The town of Newton has another $200 million in projects coming up at other schools.

    Meanwhile, a so-called Blue Ribbon commission has repeatedly warned that Newton’s budget is unsustainable, with (even before the economic collapse) 6% annual revenue increases overwhelmed by 9% annual spending increases.

    Newton is not unusual among affluent communities, wanting everything without paying for it. Think California.

  23. Only high-income taxpayers more in federal taxes than in local taxes. My gut feeling based on my own experience in different tax brackets in recent years is that for many if not most home-owning families with modest incomes, the local tax bill is highest.

  24. For those still complaining about how Prop 13 has stymied California, Mish Shedlock has a great post @

    It seems that even after adjusting for population increase and inflation since 1997-8, California State spending has increased 46%. This is the kind of unsustainable spending and ensuing taxation, that causes the most productive portion of the population in the high tax states to flee on a consistent basis.

  25. “Another irony is that when states encourage (or mandate) the consolidation of service – such as regionalizing education, towns go up in arms, claiming it as a ‘loss of local control’(at least here in MA). So people complain about the costs of government and then proceed to protest against measures that might at least, manage costs.”

    Check out BC regional districts.

    BC regional district is more sophisticated, complex and has greater variants than anything in U.S. Has been evolving with provincial support since the 1960s.

  26. “good debate” is partly right about duplication of services. The “partly” is because non-school expenses are still a smaller part of the budget than school expenses which can’t be consolidated as easily.
    The biggest problem with most local governments is that they were funded heavily from taxes and fees extracted from real estate and construction activity, which went on so long that the governments grew far beyond what can be financed from other sources.
    The other big problem is unbelievably excessive retirement commitments. In NY, until recently, pension vesting began at 5 years of service. Now a new employee has to wait 10 to vest. That is considered progress. Similarly, lifetime health benefits are vested after 10 years of service. Those commitments far exceed anything GM etc obligated themselves for. That is the big disaster coming down the road and the road is getting a lot shorter. For those progressives who are always going on about “equity” and “justice” in regard to taxes and spending, justify those entitlements.

  27. There’s the issue of special district proliferation as well.
    Talking of NYC did you read the newsday article:,0,4049924.story
    Prior to vote, special districts again in crosshairs

    Justify that!

    Meanwhile in Colorado:
    New bill seeks sunshine for state’s special districts

    And according to US Census number was over 35,000 by 2002;which according to observers of what wasn’t included means that was an undercounting!

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