Local governments' woes add to economic worries

Tim Mullaney, USA TODAY; @timmullaney | USATODAY

Amid the gains in last Friday's jobs report, one sour note stood out — state and local governments are still shrinking.

Economists had predicted that with the housing bust over, grass-roots governments would begin replacing some of the 1 million workers they've cut since 2008. Indeed, that was one reason economists thought the economy could withstand federal cuts and tax hikes this year, Moody's Analytics chief economist Mark Zandi said.

Since they're not — state and local governments cut another 3,000 workers in April, even as the economy added 165,000 jobs in all — that's adding to concerns that the economy could slow at midyear as the federal sequestration cuts begin to bite. That's especially true since budget-stressed states such as Illinois expect to add few if any jobs, said Abdon Pallasch, assistant budget director for Illinois Gov. Pat Quinn.

"I am surprised that state and local government spending is still declining on a real basis,'' Zandi said.

States are reluctant to begin hiring again because inflation-adjusted revenues are still below 2008 levels — even though populations are bigger, and obligations for Medicaid and pensions are eating up more of the budgets, said Donald Boyd, executive director of the State Budget Crisis Task Force and a senior fellow at the Rockefeller Institute in Albany. Spending on those creates few government jobs, and problems managing pensions and Medicaid will be around for years, he said.

"They know they're in for tough times, so they're not going to open the floodgates,'' he said.

Illinois is a good example. Quinn's budget calls for expanding the state workforce, now about 52,250 and down from nearly 70,000 a decade ago, to just 53,172 next year. Pallasch said one major reason is that pension expenses are "gobbling up every dollar,'' with pension spending set to rise by nearly half from 2012 through 2014.

"The only new hires we're doing are in a couple of specific programs,'' Pallasch said. "Other than that, it's pretty much just filling vacancies.''

California and its local governments have also held off on new hiring despite its recent state revenue surge, which included nearly $5 billion more revenue than expected in January. Officials are moving carefully because the surprise windfall may have been exaggerated by gains in the stock market, and by taxpayers' maneuvers to claim capital gains in December, before capital-gains taxes rose in 2013, said Jason Sisney, deputy legislative analyst for the California Legislature.

Analysts in California, where state and local governments have shed 150,000 jobs, will release new budget projections in mid-May, Sisney said. They're still deciding how to project the stock market's path, a vital decision in a state where the top 1% of taxpayers pay 40% of the personal income taxes, he said.

All states still have to worry about sequestration-driven cuts in federal aid, which will tighten their fiscal situations for fiscal 2014, said Moody's Analytics economist Brian Kessler. And because local property taxes are often based on several years' worth of assessments, rising property values will take time to boost receipts, Boyd said.

But today's challenges are an improvement compared with the yawning deficits many states have had to plug since 2008, Sisney said.

"The current trends are good news for the state's finances.'' he said. "No doubt about that.''