On the not-so-good-but-important news front, we're beginning to see how economic woes can beget further economic woes.
First, we had ailing corporate profits and rising unemployment, part and parcel with a struggling economy. Now, our nation's reduced economic activity has translated into lower corporate and personal tax revenue, resulting in the largest U.S. state budget deficits since World War II, according to Bloomberg.
The backlash of these deficits will be a combination of reduced government spending at the state level and higher state taxes -- both of which are a drag on the economy. In case you're wondering, most state constitutions disallow running budget deficits, so that's not an option. Economists cited by Bloomberg predict that the total economic impact of states' efforts to right-size their budgets could total $80 billion to $100 billion. That's enough to effectively offset President Bush's economic stimulus package.
Notable individual state deficits include: California, with a record deficit of $34.6 billion; New York, $11.5 billion; and Texas, $9.9 billion over the next two years. According to estimates from the National Conference of State Legislatures (NCSL), cumulative state budget deficits for the two fiscal years ending June 30, 2004, will total $94 billion. Those who favor smaller government will be disappointed to learn that 24 states are considering tax increases as their primary remedy, whereas only eight states have fired workers to cut costs.
Perhaps worst of all, the impact of reduced government spending and higher state taxes will put further pressure on the general economy, particularly discretionary consumer spending. As an example, Bloomberg quoted J.C. Penney Co.
Implications? In the short to medium term, investors should beware of the likely headwind facing retailers and other beneficiaries of discretionary consumer spending. With consumers being pinched at the margin, retailers are likely to face an uphill battle over the next few years (albeit with many other cross-currents that could impact spending).
In the long term, the news is a little brighter -- states may wind up being healthier and more productive for having right-sized their budgets now. Ultimately, that will be bullish. But give it time -- these deficits aren't going to correct themselves overnight.
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