Volcker, Ravitch warn state budgets under long-term threat

WASHINGTON Tue Jul 17, 2012 7:49pm EDT

Paul Volcker, former head of the United States Federal Reserve, addresses the United Nations General Assembly on the ''State of the World Economy and Finance in 2012'' at U.N. headquarters in New York May 17, 2012. REUTERS/Eduardo Munoz

Paul Volcker, former head of the United States Federal Reserve, addresses the United Nations General Assembly on the ''State of the World Economy and Finance in 2012'' at U.N. headquarters in New York May 17, 2012.

Credit: Reuters/Eduardo Munoz

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WASHINGTON (Reuters) - States' current spending, taxation and budget practices cannot be sustained, and the public must take action to change fiscal problems that go well beyond the 2007-09 economic recession, an independent bipartisan committee said on Tuesday.

"It's very difficult to get people interested in the problem and to do something about it," said former Federal Reserve Chairman Paul Volcker at a news conference, joking that the best result of the committee's work would be that the "citizenry arises" to demand change. "A lot has been going on in various state budgets, not much of it good."

The State Budget Crisis Task Force, headed by Volcker and former New York Lieutenant Governor Richard Ravitch, studied six key U.S. states and found that rising healthcare and pension costs, along with tax volatility and federal budget cuts, threaten state budget stability.

The group also warned that balanced budget requirements are often loose, allowing states to skirt difficult spending cuts, and that the use of non-recurring revenue sources and obscure financial reporting hampers effective multi-year spending.

All states except Vermont have laws requiring them to end their fiscal years with balanced budgets.

The recession caused an unprecedented crisis for many states, with their revenues collapsing just as newly unemployed people turned to their services for help in large numbers. Meanwhile, other costs, namely for healthcare and public employee pensions, continued to grow.

The committee, which included members of both political parties, academics and representatives from each state, primarily studied heavily populated California, Illinois, New Jersey, New York, Texas and Virginia.

It acknowledged in a letter that its findings "will not be surprising to many knowledgeable observers, but the facts have never been assembled in a way that reflects the totality of the problems."

Ultimately, it said, states cannot bring in enough money to cover growing costs.

FEDERAL GOVERNMENT COULD WREAK HAVOC ON STATE BUDGETS

While Medicaid, the health insurance program for the poor, has been taking up a growing part of states' budgets, the committee found that the federal healthcare law's expansion of the program will only increase state costs "moderately."

The federal government's attempts to reduce its deficit, though, could "wreak havoc on the states."

For two years, the conservative Tea Party has pressed the U.S. Congress to rein in spending and cut the government's debt and deficit. In response, Congress has slashed many domestic programs, which are often carried out by states.

The committee found that reducing federal grants to states by just 10 percent would equal a $60 billion cut, "equivalent to more than doubling the corporate income tax, cutting police and fire spending almost in half, or eliminating all spending on libraries, parks and recreation."

States are watching tax and spending negotiations on Capitol Hill nervously, aware they could be hurt by "the fiscal cliff," a combination of expiring federal tax cuts, spending reductions made in last summer's budget compromise, and other measures.

The committee warned federal proposals to make interest on municipal bonds taxable and to eliminate the deductibility of state and local taxes would raise the cost of capital projects and "also raise the effective burden of state and local taxes."

Alice Rivlin, an economist on the panel who also sat on the independent deficit reduction commission Simpson-Bowles that had suggested doing away with the interest tax exemption, said that "although we were certainly aware the proposals we made would impact state and local government, we did not do a serious analysis of what would happen."

Comparing the problems of the states with the federal government, Rivlin told the news conference that "they also face a structural deficit going forward - spending will outrun revenues, and they have limited choices on what to do about it."

"Whatever the federal government does about its problem is likely to make things worse," she added. (Reporting by Lisa Lambert; Editing by Phil Berlowitz)

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