The disturbingly large present and prospective fiscal deficits of the federal government receive much attention, and deservedly so. Yet the financial situations of many state and local government finances are also in bad shape, and in many respects they are far more difficult to solve than are the federal fiscal problems.
California provides a dramatic example. It has a current annual budget deficit of over $20 billion, which amounts to about 20% of its annual spending. My home state of Illinois is not far behind, with a fiscal deficit also of about 20% of total spending. States like Nevada even have much bigger deficits. Many cities, like Chicago and New York, also face dismal fiscal futures. Some states, like Texas, have much better fiscal health, either because they have had greater fiscal discipline, or because the Great Recession has a smaller impact on their tax revenues.
Tax revenues will recover as the American economy recovers, and that will help reduce state and local fiscal deficits. For many states, however, such as California and Illinois, the increased tax revenues from an economic recovery are unlikely to eliminate their deficits because they have a structural gap between spending and revenues. They cannot easily cut spending because a sizable fraction of their spending goes to education, welfare, health, roads, and criminal justice. All these activities have strong political support.
