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What Happens When a State Runs Out of Cash?

Arizona Treasurer Dean Martin is no stranger to handling cash shortages and other budget issues. His state has been crying recession since January 2007, when the state first ran out of cash.
“We actually beat a lot of economists to that forecast because of what we were seeing,” said Martin, who served as a state senator for six years before his post as treasurer.
In fact, a few days before Christmas 2009, Arizona’s credit rating was downgraded by Moody’s because of failure to pass a balanced budget, Martin said.
Credit ratings have declined in other states. Recently, Standard & Poor’s cited concerns over California’s finances when it downgraded the state’s only remaining “A” rating early this year, including a possible shortage of cash, according to The Los Angeles Times. But just what would happen if a state ran out of cash?
Take a lesson from Arizona, perhaps one of the hardest-hit states in the recession.
“The state’s broke, basically,” Martin said. “The state is literally out of money.” When the state first ran out of cash in January 2007, that meant basically the state’s checkbook was negative and it was burning through its reserves, he said.
That said, no matter how bad it gets, a state can’t actually file for bankruptcy, Martin said.
“The state cannot go into bankruptcy—bankruptcy laws do not apply to states,” he said. “Basically you slip into defaults, which is kind of the same thing. You bounce a check effectively and when you bounce a check you send the person an IOU.”
California has been sending out IOUs since last year; Arizona is also sending them, although not to the general public.
And that’s what happens when a state runs out of cash—the IOUs keep coming. The problem may continue as long as states don’t address structural problems within the budgets, Martin said. As long as states spend more than the revenues that come in, it spells trouble, he said.
“It’s not just the economy. The economy is about half the problem,” Martin said. “The other half was self-inflicted.”
Even though the treasurer’s office warned of the coming recession and the shortage of revenues, the warnings were ignored and the state was spending more, said Martin, who is running for Arizona governor this year.
“The operating liabilities of the state in fiscal year 2008 grew by 10.5 percent, when revenue dropped by 9 (percent),” Martin said. So that’s how the state ran out of cash, he said.
“What happens from a state perspective, as long as the state doesn’t have a permanent structural solution, they continue to erode their cash base,” Martin said. And when that happens, states will have to resort to drastic measures to bring in more cash.
Arizona sold a variety of state buildings early this year, including the archives building, the tower at the capitol that houses the governor’s office and six prison buildings in Florence, according to the Arizona Republic.
The proceeds from the selloff generated enough cash to pay the state’s bills for about a month, Martin said. The state will lease the buildings and hopes to buy them back in the future.
Drastic measures to raise cash may become more frequent as states continue to run out of money, experts say. Nearly every state faces a budget shortfall, according to the Center on Budget and Policy Priorities, and although most states have closed budget gaps for the 2010 fiscal year, all but six states face an anticipated budget shortfall for the 2011 fiscal year budget.

10 Strategies to Close the Gap

Budget gaps have states using a variety of measures to either cut spending or bring in more money. Here are some of the top strategies states are using to help the bottom line, according to the experts. But whether they’ll reap long-term benefits remains to be seen.
1 Privatize: States are considering privatizing everything from state highways to state parks. Remember the public-private partnerships hype? The Center on Budget and Policy Priorities’ Jon Shure said privatizing highways could mean “possible significant upfront money and great cost down the road (pun intended). And if these are toll roads, the state would give up revenue, long-term.”
2 Look at tax incentives, clawbacks: States are using what’s known as tax “clawback” provisions that require companies to pay back tax incentives if they didn’t meet employment or investment targets. In North Carolina, when Dell closed a plant near Winston-Salem, the company had to pay back millions in state and city tax breaks.
3 Reform sentencing laws: On releasing nonviolent offenders, Scott Pattison, executive director of the National Association of State Budget Officers, said there’s a “huge reluctance to do this although it obviously saves a lot of money.”
4 Tax Internet sales: States are watching New York’s 2008 legislation requiring Internet giant Amazon to collect sales tax from New York customers, said Sujit CanagaRetna, senior fiscal analyst with CSG’s Southern Legislative Conference. CanagaRetna said state and local governments are losing billions in e-commerce if they don’t tap this.
5 Consolidate state agencies: “Guaranteed savings could be small,” Shure said.
6 Trim pensions: “Better idea might be to raise enough revenue to fund obligations,” Shure said. Many states avoided payments instead of raising revenue, he said.
7 Consider tax amnesty programs: In December 2009, North Carolina recouped more than $420 million in back taxes owed by corporations, “which is a huge number compared to what they were expecting,”
8 Cut salaries: Virginia’s Gov. Bob McDonnell, when he took office in January, took a pay cut and cut his top advisers’ pay by 5 percent.
9 Impose four-day work weeks: Utah started the trend in 2008 and other states are following suit. “I think there’s an open question about whether it saves that much money,” Pattison said.
10 Raise income taxes on upper-income households: Shure said raising additional revenue is essential.
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