The Current Fiscal Crisis and State Budgets Jeffrey H. Dorfman The University of Georgia October 7, 2008

Outline How We Got Here Where Are We? How Bad Will It Be? State Budget Picture What to Do to Prevent this in the Future

How We Got Here Mortgage / Real Estate Mess Real estate bubble started with dot.com bust. Free markets mean booms and busts.

How We Got Here The Mortgage Market Mess Economic Incentives Encouraged Bad Loans 4 steps to the process: originator, aggregator, broker, investor. First 2 made approval decision, but bore no risk.

How We Got Here Source: Federal Reserve

How We Got Here State Government Role Spending has increased a good bit last few years. States have not been raising taxes. States used poor economic forecasts and waited too long to see this slowdown coming (GA ex.)

Where Are We? Economy Retail Sales Stock Market Real Estate Values Consumer Confidence Manufacturing State Borrowings

Where Are We - Economy GDP grew 2.8% in Q2, mostly due to stimulus checks. Unemployment up to 6.1% (from 4.7% one year ago). Job losses 159,000 last month.

Where Are We – Retail Sales This is $4 trillion / year and very important to states since it translates directly to sales tax collections. Up 2.1% year over year, but only +0.2% in last quarter. Source: US Census Bureau

Where Are We – Stock Market Back to levels from 4 years ago. $4 trillion in lost wealth. Source: NASDAQ

Where Are We – Real Estate Nationwide 20% price drop (Case-Shiller) Many states are not that bad million homeowners now have zero or negative home equity.

Where Are We - Consumers Source: Conference Board

Where Are We – Manufacturing Source: Institute for Supply Management

Where Are We – State Borrowings California is worried about borrowing $7B. Mass. pulled a $400M bond offering. New Mexico delayed a $500M bond offering.

How Bad Will It Be? Look at 4 sources of revenue and economic growth: Consumer Spending Personal Income Corporate Profit and Investments Government Spending

How Bad Will It Be? - Consumers Consumer spending will be slowed by Wealth effect from stock market decline - $100B Wealth effect from home value decline - $60B Spending drop from drop in refinancings - $200B That means we could see 6% drop in retail sales. That is a 1.8% drop in GDP.

How Bad Will It Be? – Income Unemployment up 1.4% and climbing. Capital gains will be very low in Raises and bonuses will be low. Interest and dividends will be down. Total effect could be 6-7% drop. That is about 4% drop in GDP.

How Bad Will It Be? - Businesses Corporate profits down 7.1% in last 12 months (Jim Jubak, MSN Money) Estimated change in business investment is 30% decline. Together, could drop GDP 3%

How Bad Will It Be? - Government Federal spending is increasing Stimulus, plus all other programs Probably enough to boost GDP 2% State and local government spending will drop. May be offset for federal govt, may be more.

How Bad Will It Be? - Summary Estimated changes in Sales taxes:-6% Income taxes:-6% Corp. taxes:-7% at a minimum Federal dollars:???? Most states seem likely to experience 7% decline in main revenue sources.

State Budget Picture 8 states used rainy day funds in FY08. AL, GA, VA 20+ states with revenue below projections. AL, FL, GA, KY, MD, TN Most states still have good reserves Problems: AR, KY, MS, SC Source: National Governors Association

State Budget Picture < 0%0 – 3%3 – 6%6+% AL, FLGA, MSAR, MDLA, MO KY, SCOKNC TN, TX VA, WV Expected State Revenue Growth Source: National Governors Association

State Budget Picture Source: National Governors Association

Future Improvements for Recessions Project state revenues by category. Sales tax, income tax, corp tax, (cap gains tax). Realize that corp income tax and cap gains taxes can turn south very quickly. Try to pair them with programs that can be cut quickly. Set revenue target at lower limit of 95% CI.

Future Improvements for Recessions The idea for revenue forecasting would be that 95% of the time, you would end up with extra revenue.

Conclusions We are in or going into a recession. It will probably be a reasonably severe one. I’m glad I’m not a state legislator right now.