THE STATES ARE STRAPPED, BUT THEY'VE GOT MONEY TO BUILD
By JOSEPH SPIERS CHIEF ECONOMIST Vivian Brownstein STAFF ECONOMIST Joseph Spiers RESEARCH ASSOCIATES Lenore Schiff and Lorraine Carson FORTUNE's forecast is produced by this magazine's economists using our own economic model.

(FORTUNE Magazine) – Mario Cuomo, the quintessential tax-and-spend Democrat, has just signed off on a New York State budget calling for yet another increase in outlays. But what an increase -- a distinctly unwhopping 3%, about the same as inflation. What's more, the governor is cutting health and welfare. The budget raises revenue by some $1.3 billion, mostly through rescinding scheduled income-tax cuts. More funds will also flow from higher levies on nursing homes, hospitals, and health insurers, as well as increased license-plate and other fees. But there will be no in-your-face tax-rate increases. Why care about all this unless you live in New York? The reason, say state fiscal experts, is that its budget for the year that began April 1 will likely set a pattern for the rest of the country's strapped states, most of whose financial years start July 1. As a taxpayer, that means you won't get nicked nearly as much as last year, when states legislated a record jump in taxes and fees of more than $15 billion. Counties and cities face the same kind of pressures to hold down spending and taxes. But get this. Even as cries mount for greater federal help for investment in infrastructure, these same state and local governments are set to spend a bundle on projects like roads, bridges, tunnels, and sewers. In 1991 they raised a record $55 billion through bond sales, according to the Public Securities Association. That was up 41% from the previous record in 1990. This year's first quarter saw a further 58% increase. That's new money -- the figures exclude the huge amount of refinancings made to take advantage of lower interest rates. (For ways to play the municipal bond market, see Personal Investing.) After dipping early in 1991, public construction has been rising at a smart 11% annual rate, adjusted for inflation, during the past half year. The surge in bonds does not point to an identical boom in construction because some of the borrowed money is probably replacing funds that would otherwise have come from general revenue. Still, the sales ''are a reasonably good leading indicator'' of construction, says John Peterson, president of Government Finance Group in Washington. How is it that infrastructure is getting so much when legislatures are wrangling over how to divide up a diminished fiscal pie? Easy: Construction spending -- $89 billion last year -- accounts for only about 15% of state and local purchases. With bond-financed infrastructure projects, governments can create jobs now and dribble out the debt-service repayments over a long time. It's also a good time to hire construction companies, since slack private- sector work has prompted aggressive bidding, says Peterson. Adds Ronald Snell, fiscal program director at the National Conference of State Legislatures: ''Many people in state government are convinced infrastructure is the key to growth.'' Growth certainly won't come from the state and local general budgets. Despite the many tax increases enacted last year, these remain under tremendous strain. Revenues are generally coming in under target because the economy has been so slow. Even if they pick up more than expected during the year, the increase won't fund renewed big spending (see chart) because governments must shore up depleted reserves that have dropped to an extremely low 1% of expenditures. Thus while most states will avoid raising taxes outright, their residents are likely to get hit with not-so-obvious charges, like having to pay the same old sales tax on a broader array of products. The Tax Foundation, a Washington research group, surveyed state governments recently and calculated that fiscal 1992-93 budgets will call for revenue increases of about $7 billion. Besides New York, the biggest dough raisers will be Florida, Louisiana, Maryland, and Alabama. The widely anticipated 2% to 3% growth in the economy will still leave states struggling to meet the built-in spending demands of Medicaid and other mandates, says Hal Hovey, who keeps a close eye on the fiscal follies as editor of State Budget & Tax News. Meanwhile, with elections approaching, antitax sentiment is abroad in the land. FLORIO-FREE IN '93, say bumper stickers in New Jersey, where Democratic Governor Jim Florio raised taxes by a record $2.8 billion in 1990, prompting a Republican landslide in the 1991 legislative election. With such examples in mind, most governors and legislatures will try to hold down tax increases and cut spending on once sacrosanct services. Hovey expects higher education to take a haircut, with less aid as one blade of the scissors and higher tuition the other. Primary and secondary school aid in many places will get frozen -- a reduction in real terms. Writ large, California illustrates the exquisite predicament of the states. Last year it legislated revenue increases, including higher income- and sales- tax rates, totaling an enormous $7 billion. Yet it still faces a deficit of about $6 billion through next fiscal year. Governor Pete Wilson has targeted welfare programs. The legislature opposes the governor, who is working to bring his proposal to a public referendum in November. The pols could boost taxes or reduce education spending -- political suicide in either case. So the tactic of choice is to nickel and dime everything they can while delaying major decisions. $ TO ESCAPE THE BIND of higher taxes or fewer services, more and more officials are talking the language of their private-sector counterparts -- competitiveness, efficiency, customer service, total quality management. Governor Lawton Chiles of Florida vows he will trim the fat by merging departments, privatizing services, and boosting efficiency through incentives. The state has experimented with productivity bonuses for worker-compensation clerks, who have responded by doubling their output in some cases. But most attempts at ''reinventing government,'' to use the current buzzwords, are recent. And the payoff won't come quickly or add up to megabucks, analysts say. Skeptics worry further that efficiency moves are born out of fiscal necessity, not out of commitment, and that bloat will creep back once an improved economy starts filling up government coffers again. Right now, however, the school of hard knocks is forcing some states to pare payrolls and pinch paychecks. New York has shed 20,000 people since its employment peaked in early 1990. Florida's leaders nixed a scheduled 3% pay raise for government workers. Nationwide, public employee labor contracts negotiated in 1991 provide for 2.8% annual increases, down from 5% or more in the 1980s. You may not applaud such declines in employment or pay raises, but if rough times drive up efficiency in government -- as it has in private industry -- ultimately everyone will benefit.

BOX: OVERVIEW

-- State taxes will rise, but not as much as last year. -- Tight budgets will squeeze once sacrosanct services. -- Yet governments are raising record amounts in the muni market for construction.

CHART: NOT AVAILABLE CREDIT: FORTUNE CHART CAPTION: State and local government spending A SWITCH TO INVESTMENT Slow growth has cramped revenues, so state and local government spending is going nowhere. But record bond issues are underwriting investments in infrastructure. This bridge across the Connecticut River in Old Saybrook will replace the aging one at right.