State and local governments should be listed as a primary risk to the US outlook

I don’t see why the aggregate state funding gap is not numero uno on the ‘risks’ to the US outlook (I usually hear oil, Europe, China, etc., in my line of work). According to the Center on Budget and Policy Priorities, the State budget gap is not expected to clear at least through 2013. From the CBPP report “States Continue to Feel Recession’s Impact“:

Three years into states’ most severe fiscal crisis since the Great Depression, their finances are showing the clearest signs of recovery to date. States in recent months have seen stronger-than-expected revenue growth.

This is encouraging news, but very large state fiscal problems remain. The recession brought about the largest collapse in state revenues on record, and states are just beginning to recover from that collapse. As of the first quarter of 2011, revenues remained roughly 9 percent below pre-recession levels.

Consequently, even though the revenue outlook is better than it was, states still are addressing very large budget shortfalls.

Better put: state revenues are rising more quickly than expected from a low base following the most precipitous drop ‘on record’. Not feeling too confident here.

(MORE AFTER THE JUMP)


Whether or not this ‘surge’ will continue depends on the labor market, corporate profits, and retail sales – heck, aggregate demand. There’s an obvious connection between retail sales and state sales tax revenue, and retail sales are weakening. In May, the pace of the 3-month moving average of retail sales slowed to 0.27% (from a peak of 1.09% in October 2010), while that of real retail sales fell 0.11% over the month (raw data here). Lower gas prices will help; but without significant relief in the labor market (from the private sector), the pace of revenue growth is unlikely to be maintained.

It’s not just the states – the health of state and local government’s (or lack of) matters A Lot for the US economy.

On average, state and local governments jointly are the largest single contributor to aggregate compensation in the 1990′s and 2000′s (roughly), according to the Bureau of Economic Analysis.

Since 1987, State and Local governments have accounted for an average 13% of total compensation of the US economy. So the outlook for 13% of aggregate compensation essentially depends on jobs growth in these sectors.

The trend for job growth has been decidedly negative for state and local governments. State and local governments have net-fired workers every single month since November 2010.

State and local governments are doing something they’ve not or rarely done before: hinder nonfarm payroll growth. In May 2011 (the latest data point), state and local governments dragged annual total payroll growth by 2% and 20%, respectively. Local government payroll was 11% of the total in May. This is not good.

Federal government support to state and local governments is set to decline significantly next year (see figure 2 on html of CPBB report). So it’s up to the private sector to provide sufficient income growth to offset the likely decline (latest data is 2009) by the giant of aggregate compensation, state and local governments, for years to come. I’m skeptical.

Rebecca Wilder

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