States of Decline

"Eight years ago, Connecticut's economy was in decline," the campaign ad flashed across television screens last spring. "Thousands of jobs lost. Taxes going up. Education failing. Governor John Rowland set out to change all that and today the positive results are everywhere. ... Now some Democrats want to reverse our progress and raise the income tax. Don't let the legislature tax and spend Connecticut into economic decline. Call your lawmakers. Tell them to keep Connecticut working."

The ad, paid for by Connecticut Republicans, helped re-elect the staunchly anti-tax, pro-business Rowland to a third term. Less than one month after winning re-election, however, Rowland, who also chairs the Republican Governors Association, has conceded that he will have to raise taxes to keep the state afloat. Connecticut is facing such a dire fiscal gap -- a two-year shortfall of around $2 billion -- that Rowland accepted a 1 percent surtax on the state's 6,500 wealthiest residents, who have adjusted gross incomes of more than $1 million each. Only seven months earlier, Rowland had vetoed that very proposal.

Not only will Rowland raise taxes, he also plans to cut jobs: More than 2,800 state employee positions will have to go. So will alternative sentencing programs for addicts and the mentally ill, dental and vision services for people on Medicaid, and need-based scholarship aid to college. State aid to cities and towns will also decrease, which means that localities will have to raise property taxes in order to continue funding schools.

Taxing and cutting -- it's not exactly a winning political formula. But it's what Republican and Democratic governors alike are doing all across the country as the states face what the National Governors Association (NGA) has called the worst state fiscal outlook since World War II. "Nearly every state is in fiscal crisis," reported the NGA in a grim November survey of the states. In 2002, 26 states enacted cuts and 15 laid off state employees. In 2003, 23 states plan to reduce their budgets -- and programs. Liberal Massachusetts, with a Republican governor, slashed 50,000 people from the Medicaid rolls. Democratic California is cutting $10.2 billion in state spending -- mainly in education, from kindergarten through community college, and medical aid to the poor -- to offset a $23.6 billion budget shortfall.

As governors from both parties struggle with tough choices about which meat-and-bone programs to cut, the Republican governors are having to make a tough political choice as well: whether to ally themselves with a president who does not want to give the states a federal bailout or with their Democratic counterparts who are hoping for help from Washington. Further complicating matters, nearly half the states will be run by newly elected governors, many of whom owe at least some of their electoral success to the president.

Republican governors, who control 27 statehouses until January and will control 26 thereafter, have, on occasion, rallied over the past two years with their Democratic counterparts to urge President Bush, a former governor himself, to give them federal assistance. In May 2001, 37 governors, including Rowland, urged the president to allow states to set their own policies on estate taxes, a major source of revenue that the Bush administration hopes to eliminate. But Republican governors have also sought to use the state fiscal crises for more ideological purposes, such as pushing for service cuts, concessions from public-sector unions and privatization of state functions. Other Republicans have tried to have it both ways, first rallying to the president's side and then publicly leading the charge for a federal bailout. Gov. John Engler (R-Mich.), for example, vocally backed the Bush tax cuts in early 2001 and won praise from Democrats in 2002 for advocating on behalf of all states during his term as NGA chairman. He refused to raise Michigan's income taxes (despite the state's looming $1 billion gap), proposed $845 million in cuts to local government and punted the state's problems to incoming Democratic Gov. Jennifer Granholm.

Tax-intake problems, in fact, are one of the main reasons the states are in dire straits. During the 1990s, most states saw higher-than-usual tax receipts, thanks to soaring capital gains earnings and the booming stock market. And like Connecticut, which cut its tax intake by more than $2 billion since 1995, many made permanent fiscal decisions based on what turned out to be a temporary upsurge in funds. Forty-three states enacted substantial tax cuts between 1994 and 2001. The impact of September 11, the recession, local tax cuts, a boom-time expansion in services and growing Medicaid costs -- which surged 13.2 percent in the last fiscal year, largely because of increasing prescription-drug prices -- have now led to an economic "perfect storm," NGA Executive Director Raymond C. Scheppach recently told state budget monitors.

The looming state fiscal crisis didn't stop Bush from pointing to the state tax cuts when pressing for his national one, however. "The surging growth we have seen in the states that have reduced taxes gives an answer to those who say we cannot afford tax cuts," Bush said at an NGA meeting in February 2001. But the federal tax cuts, and consequent re-emergence of a federal deficit, may well impede the ability of the states to rely on the federal government to help them out.

One of the main items on the governors' agenda is an increase in the Federal Medicaid Assistance Percentage (FMAP). (Public K-12 education is the single largest state expense for all states; Medicaid follows a close second.) But a bipartisan bill to increase FMAP, the State Budget Relief Act, was opposed by the Bush administration, despite support from all but a few Republican governors. The bill, which had 172 co-sponsors, stalled in the House of Representatives earlier this year; the Senate added the bill's FMAP provisions in a 3-to-1 vote to the prescription-drug buyback bill, which also died in the 107th Congress. Knowledgeable political observers suspect that the Bush administration will now drag out the state-relief debate until the governors are so desperate that any federal assistance, no matter how paltry, will seem a major boon.

Whether Bush or the governors pay any political price for the impact of state deficits on regional quality of life remains an open question. Certainly, the busted budgets contributed to the fact that voters in 20 of the 36 states holding gubernatorial elections last fall threw out the candidate of the incumbent party. In the near term, both parties will likely see some risks: Though only three gubernatorial seats are coming up for election in 2003, and 11 in 2004, those 14 seats are nearly evenly split between the two parties. Historically, local problems -- even if national in origin -- have been blamed on local politicians.

The widespread nature of the current problems may alter that dynamic, some observers say. "Politics is local, and in many respects the most important government services are also local," notes Shelly Geballe, the Connecticut attorney who first proposed the millionaire's tax that Rowland eventually adopted. "It could threaten the re-election of President Bush if, by the time re-election comes around, we have this massive meltdown of state services."