States Facing Budget Shortfalls As Housing Slump Hits Tax Take

Investor's Business Daily

Revolt Commentary:

The following article further highlights the problem with the property taxation system in Arizona and many of the other states where government revenue is determined in large part by property valuations which during boom cycles swell government coffers. Like drunken sailors on pay day, government grows their programs rather than staying on a sustainable course. When the inevitable cyclic downturn occurs their first reaction is to increase tax rates to compensate for the market downturn. Perhaps this makes sense to our out of touch representatives on the governing boards of the taxing entities but it means even higher taxes for us taxpayers at a time where we can least afford to pay.

The Arizona Tax Revolt measures will not only reduce property taxes, they will also assure that in the future taxes will be predictpredictable and affordable. This will improve revenue linearity to government softening the boom and bust cycles and the resultant waste of tax revenue due to their use it or lose it mentality.

Marc Goldstone, Chair.
Arizona Tax Revolt

Published: December 05, 2007

Homeowners aren't the only ones squeezed by the deepening housing market crisis.

So are schools, prisons, crisis hot lines and even Florida manatees.

State and local government coffers are getting hammered as income dries up from taxes and fees stemming in large part from the once booming housing market.

Budget shortfalls mean lawmakers must cut back services and programs. In Florida, for instance, that will mean fewer fish and wildlife officers to enforce speed zones in manatee areas to skimpier health benefits for employees in North Miami Beach.

Belt tightening will impact many parts of the country, says Robert Kurtter, managing director of public finance for Moody's Investors Service.

"Lower revenue and collections puts pressure on services such as schools, roads and parks," he said. "And it potentially puts pressure on property tax rates to rise."

The impact is only now hitting home, since most states started their new fiscal year July 1, when they still had healthy reserves carried over from the boom years.

While state spending grew 9.3% in fiscal 2007, spending is expected to grow only 4.7% this fiscal year, well below the 30-year average. The findings were reported Wednesday by the National Governors Association and the National Association of State Budget Officers.

Local governments, which rely heavily on property taxes, are expected to get hit especially hard. States have more income sources and better borrowing abilities.

Compounding the problem in some states (Florida most notably) is the decline in value of state-run investment funds pooled from local governments and school districts, due in part to subprime exposure.

Florida last week froze its local government fund after holdings plunged to $14 billion from $27 billion. Panicked local officials had pulled large sums on fears of subprime losses. Limited withdrawals are now allowed.

Fiscal experts generally agree that the hardest-hit states are expected to be where housing has had the sharpest run-ups and subsequent falloffs, such as in California, Florida, Nevada and Arizona.

Since July, Florida has twice adjusted its revenue forecasts down for the current fiscal year as the housing market continued to deteriorate. In addition to the $1 billion recently cut from the state budget this year, lawmakers might have to cut $1.5 billion next year.

California officials figure the state must come up with almost $10 billion to balance next year's budget. Arizona is looking at a budget shortfall of at least $400 million, much of it due to housing woes. Nevada's budget gap is said to be nearly $300 million.

The U.S. Conference of Mayors said in a report last week that homeowner property values will drop by $1.2 trillion in 2008. It projected $6.9 billion in potential losses from housing-related tax revenues in 10 states alone.

California Tax Bust

California metro areas will be hit hardest, with property taxes alone dropping by almost $3 billion.

RealtyTrac said Stockton, Calif., Detroit and Riverside-San Bernardino, Calif., had the highest foreclosure rates in the third quarter of the 100 largest U.S. metro areas.

Other cities with high foreclosure rates included Fort Lauderdale, Fla., Las Vegas, Sacramento, Calif., Cleveland and Miami.

Michigan, Ohio and other parts of the industrial Midwest never enjoyed a housing boom. But they have been hurt by auto and other manufacturing job losses.

Since states rely heavily on sales tax receipts, they're feeling the effects of the housing and mortgage crisis as pinched homeowners cut back on spending. During the housing boom, consumers spent freely on furniture, fixtures and other goods.

States also feed off personal income taxes (Florida is one state that doesn't tax personal income), real estate transfer taxes and corporate taxes.

While local officials were caught off guard by the turn of events in Florida's pooled fund, they have time to adjust to changes in property taxes. It takes a while for assessments to change. The lag in property tax adjustments gives local governments "time to plan for downturns so they are not caught by surprise," said Kurtter.

Though property taxes have gone up in the last couple of years in some areas as home values soared, many states have caps in place. Efforts to lower or cap property tax hikes have been or are under way in several states, including New Jersey and Florida.

California's Proposition 13 long ago lowered property taxes by 60% and limited the degree of annual rate hikes. In doing so, school funding was transferred from local property taxes to state revenue sources.

It's not all about values of existing homes. A slowdown in new residential construction means fewer new property-tax dollars are rolling in.

In many areas, commercial construction has been taking up some of the slack in new-home starts. But even the commercial property sector is starting to feel pressured, says Kurtter.

"Up until recently, the commercial real estate market was oblivious to the credit crisis in the market," he said. "Now we're seeing some problems spread into that sector too, which is a concern for local governments trying to build new multiuse and industrial projects. Some of these projects -- which would increase their tax base -- are potentially jeopardized."

Florida Budget Swamp

Not all budget deficits will have equal impact. Heading into the current fiscal year, Florida, for example, had healthy reserves. Unlike other states that felt the brunt of the tech crash and recession in 2001 and 2002 -- California being among the worst hit -- Florida's economy kept charging on.

At its peak reserve level in fiscal 2006, Florida had about $6 billion in its general reserve, says Robin Prunty, senior director of the public finance group at Standard & Poor's. (NYSE:MHP) In addition, more than $2 billion is still pretty much intact from a tobacco settlement.

Florida has been spending judiciously, watchers say. But as revenue falls, it has been drawing on reserves. After the fiscal year began, Florida made state agencies cut spending across the board.

"It speaks to management in Florida recognizing the shortfall and taking action to address it," said Kyle Gephart, associate director in Fitch Ratings' state public finance group.

Though California Gov. Arnold Schwarzenegger has asked state agencies to trim 10% from their budgets to fill the $10 billion gap, no budget-balancing measures have yet been implemented.

In November, Standard & Poor's downgraded California's rating outlook from positive to stable, meaning it doesn't see any upside to the state's credit rating in the next one to three years.

Moody's gives California its second lowest credit rating, after Louisiana. The state has had a low credit rating since 2002.

Until recently, California's fiscal health had been improving. A large part of its current budget involves payments on past loans.

Some see California's glass as half full rather than half empty. Housing aside, the state's economy is "reasonably strong," says Stephen Levy, director of the Center for Continuing Study of the California Economy.

"The past two downturns in California were led by a very severe cutback in one of our lead industries," he said. "In 1990 it was aerospace. In 2000 it was the crash of the Internet bubble." While the prior downturns "raised questions about the long-term survival of our base industries," today's housing crisis is part of a "cyclical" situation, he says. "It's a nasty turn, but it's not like it threatens one of our key industries forever."

In some pockets of the country, the housing market has held up, including Seattle; Charlotte, N.C.; and New York City.

"New York City lowered its financial forecast slightly. But there was nothing really dramatic at both the city and state level," Prunty said.

But that could change. With mounting losses on Wall Street in financial services due to the subprime mess, New York City is "now at risk," Kurtter says.

Potential Tax Losses

Fiscal 2008, in millions*

California $3,988
Florida 836
New York 830
Illinois 357
Massachusetts 278
Arizona 227
Georgia 165
Michigan 124
Nevada 76
Minnesota 36

*Includes possible revenue shortfalls in property, sales and real estate transfer taxes in selected states Source U.S. Conference of Mayors