Fiscal aftershocks

Economic growth of 3.5 percent in the third quarter of 2009 may mark the end of the Great Recession, but state and local governments will likely feel ongoing negative effects throughout 2010 and beyond. Unemployment rates near double digits will continue through the next year, and governments will continue to endure the collateral effects of weak tax revenues, lower property values, slower consumer spending and other negative economic factors. But for the infusion of federal stimulus money, it would be a lot worse.

IHS Global Insight, a Waltham, Mass.-based economic forecasting company, predicts 2.2 percent growth in gross domestic product (GDP) in 2010 and 2.9 percent growth in 2011, both reflecting a turnaround in the U.S. economy, which shrunk 2.5 percent in 2009.

Even with more stimulus funds still in the pipeline and scheduled to be spent throughout 2010, state and local government growth will be barely existent (0.1 percent) in 2010, after a slight dip in 2009 (- 0.1 percent), according to IHS Global Insight. The firm forecasts state and local government growth to again become negative in 2011 (- 0.1 percent), suggesting a possible need for another round of federal stimulus funding in the future. "They will be looking for more help from the federal government, and there is greater risk unless there is further support [from the feds]," says Nigel Gault, chief U.S. economist, IHS Global Insight.

"Stimulus funding made a difference of a couple of percentage points [in overall GDP] in the second and third quarters this year, and the gradual phasing-in of funds continues to be a plus for growth through the third quarter next year," adds Gault. "A year in the future, the private sector will be in better shape to take the economy forward."

Gault also sees swings in the "inventory cycle" helping to boost growth in the next few months as companies gear up to build back inventory levels that declined during the recession. Fewer workers, as demonstrated by unemployment now above 10 percent nationally, are producing more, as reflected in soaring productivity rates for companies. But there are limits to how long companies can operate with fewer workers and aggressive cost-cutting.

Historically, spikes in productivity have been a signal that the labor market is about to rebound, says Gault. Other hopeful signals about the jobless situation are increases in manufacturing overtime and temporary employment. "There are positive early indications, but it hasn't turned yet," says Gault. "There is a prospect of it turning in the next several months." He notes that unemployment rates will also benefit from hiring next year for the U.S. Census, which will involve more than a million workers at various times.

"The financial clouds are lifting," says Gault. "But it's not yet smooth sailing."

State budgets wrecked by recession

The dire effects of the recession are wrecking state budgets through the rest of the 2010 fiscal year and into the 2011 fiscal year, says Sujit CanagaRetna, Council of State Governments fiscal analyst. The intensity of the fallout continues to deplete state coffers as revenue intakes sputter and expenses escalate. State tax collections for the fiscal year 2009 plummeted by an average 9.2 percent, adjusted for inflation.

"More alarming is that new budget gaps [have recently] opened in 18 states, with more states expected to join the list," says CanagaRetna. Cumulative budget shortfalls for the 2010 and 2011 fiscal years are forecast at $350 billion. "States are looking at a grim immediate future."

In preparing their budgets for the 2010 fiscal year, gaping budget holes prompted 41 states to reduce services, including restrictions on eligibility of low-income children and families for health insurance or reduction in access to health care services in 27 states. In addition, at least 24 states slashed medical, rehabilitative, home care or other services needed by low-income elderly or people with disabilities, or raised the cost of these services. Twenty-five states either cut or proposed cuts in K-12 and early education; 34 states cut funding to public colleges and universities; and 42 states shrank the size or work time of state government employees.