State budget crunches will slow U.S. economy: study

Allison Bleakley rests among signs during a rally against government cutbacks for social services in Aurora, Illinois, June 18, 2009.

NEW YORK (Reuters) - Severe budget crunches afflicting U.S. states will put the brakes on the national economy by as much as seven-tenths of a percent of Gross Domestic Product in the next 12 months, according to a Goldman Sachs report.

That is a reversal from the usual pattern, when states and municipalities can help cushion a national decline that crimps GDP, the broadest gauge of a nation's goods and services, according to the report, published on Friday.

Most states are obligated by law to balance budgets, forcing them to slice spending at the start of a downturn.

This time, however, many state budgets were overtaken by events beyond their control. Many states were still increasing spending, in real terms, through the third quarter of 2008, a full nine months into the recession, the report said.

The U.S. stimulus plan approved in February will fill in about two-thirds of the $121 billion of the total budget hole that the Denver-based National Conference of State Legislatures said U.S. states face in fiscal 2010, according to Goldman's estimates.

"Finding $40 billion to $45 billion in additional budget savings might seem like child's play after the experience of the past year," the report said.

"However, we expect this amount to balloon as revenue shortfalls persist in an anemic recovery, with real GDP only rising about 1-1/4 percent between now and the middle of 2010."

Most U.S. states end their fiscal year on June 30.

The current recession has already outlasted all but two post-World War Two downturns. Goldman said states may have to raise taxes or reduce spending by $80 billion to $100 billion, partly because they have already tapped rainy day funds.

STEEP DROP IN TAX REVENUES FORESEEN

Personal income tax revenues could be disappointing, falling 10 percent to 15 percent or $32 billion to $47 billion below projections in the next 12 months, Goldman said, citing falling employment and wage "stagnation."

"Sales tax receipts are apt to weaken further, also surprising officials," Goldman said.

The report forecast that nominal consumer spending will rise only 0.6 percent. That means states could see sales tax revenue sag 2 percent instead of growing at the 3 percent clip that states are expecting.

Corporations likely will pay less in taxes "though the magnitude of the surprise should not be large," as states only receive about $44 billion from this source, Goldman said.

At both the state and local level, the housing market remains a risk. Many counties, cities and towns rely heavily on the property tax for funds.

"Risks tilt to the side of a larger drag if the economy disappoints or if local jurisdictions suffer losses in property tax revenue," the study said.

(Editing by Jan Paschal)