Market Crash's Aftershocks Could Force Cuts in States' Aid to Schools

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The economic consequences of the historic plunge in the stock market in October could force some states to cut their spending on education in the coming year, economists and fiscal analysts are warning.

While few forecasters are predicting an outright recession as a result of the Wall Street crash, most agree that the record drop in the value of stocks will cause a sharp slowdown in economic growth in early 1988.

Slower growth, analysts note, will mean lower-than-expected revenues for state governments, thus forcing some legislatures to either raise taxes or cut budgets to make up the difference.

And with education costs accounting for more than a third of all state spending, pressure could grow to trim school programs, cautioned state budget officials and other experts in recent interviews.

Lower revenues, coupled with increased costs of welfare and other assistance programs stemming from a sluggish economy, could "put immense pressure on education budgets," said Gerald Miller, executive director of the National Association of State Budget Officers.

The market crash that hit Wall Street oninued on Page 14

Market Crash May Force Aid Cuts

Continued from Page 1

Oct. 19--widely known as "Black Monday"--wiped out nearly $1 trillion in financial assets in a few hours. Stock prices have recovered somewhat since then, but economists predict that consumers worried about the outlook for the economy will spend less than usual during the coming Christmas shopping season.

Although only about 27 percent of all Americans own stocks, economists note, turmoil in the financial markets could prompt many people to become more cautious with their money, leading them to forgo discretionary buying and defer the purof expensive items, such as automobiles and houses.

Such reductions in consumer spending, experts explain, can create a downward spiral by causing businesses to cut back on investment and to lay off employees--actions that in turn lead consumers to spend even less.

How Big a Slump?

Although most economists foresee a reduction in economic expansion next year, opinions differ greatly on how severe the slump will be.

Data Resources Inc., a major forecasting firm, has sharply lowered its estimate for 1988 growth in the wake of Black Monday, said Sara Johnson, a senior economist with the firm.

Data Resources, she said, now expects a 1.7 percent increase next year in the Gross National Product--the most widely used measurement of the economy's vigor. Before Black Monday, the firm had predicted that growth in the gnp would reach 2.6 percent in 1988.

In a poll conducted at the beginning of November by the University of Chicago Graduate School of Business, 30 of the nation's most influential economists made similiar predictions. According to the survey, the respondents' average forecast for growth in the gnp next year was 1.9 percent, down from 2.8 percent before the crash.

While such reductions may not seem large, a slowdown in economic growth of even 1 percent of gnp would cost the nation nearly $50 billion in lost income next year.

For the states, such a decline would have an almost immediate effect on revenues, especially in the 10 or so states that depend on sales taxes for the the bulk of their funds.

And because many states do not tax necessities, such as food and medicine, they are even more vulnerable to an economic slowdown, said Ms. Johnson. In an economic slowdown, she explained, sales of the discretionary items that are taxed by the states would be affected more than sales of the essential goods that are not taxed.

Recession Danger

Few economists are currently forecasting a recession--an actual reduction in the gnp over two or more fiscal quarters--but many are warning that the stock-market crash has left the economy weak and highly unpredictable. Any further bad news, they say, may lead to a recession.

Such bad news could come from a number of directions, Ms. Johnson and other economists say.

Further reductions in the value of the dollar, for example, could spur foreign investors to move their funds out of the United States. This might force the Federal Reserve Bank to raise interest rates, which would further weaken the economy.

"The risks have increased," Ms. Johnson warned. "We are clearly more dependent on decisions made abroad as a result of our huge trade and budget deficits."

Investors and financial analysts on Wall Street are keeping theirn Washington, as President Reagan and Congressional leaders from both parties seek approval for a compromise package of budget cuts and tax increases designed to reduce next year's deficit by about $30 billion. Economists fear that unless the deficit is significantly and quickly reduced, interest rates will have to go up, despite the risk to the economy.

At a recent conference, Mr. Miller of nasbo said, members of his association generally agreed that growth in state revenues next year would be between 0.5 percent and 1 percent lower than expected.

While that would mean a reduction of as much as $2.4 billion in total state revenues, losses would vary from state to state, depending on their tax systems and the health of their local economies.

Before the crash, nasbo had predicted that total state revenues would grow by a healthy 6.2 percent next year, based on the organization's annual survey of budget officials.

"Almost all of them are taking the figures they gave us then and revising them downward," Mr. Miller said.

Budget officials in several states say they have not yet revised their revenue forecasts, but are keeping a close eye on developing trends.

Watching for Trends

"I'll be monitoring sales-tax receipts very carefully over the next couple of months," said Shelby Solomon, director of the Michigan Department of Management and Budget.

"If we begin to see reductions during the Christmas season," he said, "then we'll know we need to make adjustments in our [revenue] forecasts."

With many states already nearly five months into the 1988 fiscal year, any unexpected revenue losses would be difficult to make up without tax increases or budget cuts, analysts said.

"I think it's pretty clear that if revenues start to fall, even a little bit, then there will have to be some cutbacks," Mr. Miller said.

In the large number of states that operate on two-year budget cycles, officials may find themselves forced to rethink long-term economic predictions for fiscal 1989 given the current fiscal uncertainties.

According to Mr. Miller, most states have little or no surplus to cushion them against an economic slump. Ending balances and "rainy day" funds, he said, are at an all-time low.

Even before the crash, the combined end-of-the-year surplus for all of the states in fiscal 1988 was expected to be about $3 billion--only 1.3 percent of their total expenditures.

In economically hard-pressed Texas, for example, state officials say their budget has a $200-million surplus for the biennium that ends in 1989.

"That's cutting it pretty close when you're looking out over two years with a $28-billion budget," said James Oliver, director of the state's legislative budget office.

Fiscal analysts generally recommend that states maintain a reserve fund equal to 5 percent of the annual budget. But as of September, only five states--Connecticut, Delaware, Michigan, Nevada, and Wyoming--had met that target for fiscal 1988.

Before the crash, three states--Alaska, Louisiana, and West Virginia--were projecting that they would run budget deficits next year. Asked if other states should be added to that list, Mr. Miller said, "Not yet."

'Immense Pressure'

While states that are heavily dependent on sales-tax revenues would feel the first effects of an economic slowdown, a prolonged recession would strike harder at those states that rely on income taxes, analysts say.

This is due to the fact that consumer spending usually falls faster than personal income in the early stages of a recession.

Later in a downturn, that situation is reversed, as a result of employee layoffs and demands by businesses for lower wages.

On the spending side, hard economic times frequently drive up the cost of welfare, Medicaid, and other public-assistance programs, and thus increase the competition schools face for scarce state budget dollars, Mr. Miller noted. "There's no question that increases in [assistance programs] can put immense pressure on state education budgets," he said.

But the outlook for school funding is more favorable at the local level, according to Mr. Miller and other analysts. Property taxes, the primary source of local school revenue, are largely immune from the ups and downs of the business cycle.

This is particularly true in communities where assessments are capped at levels far below market value, said Ms. Johnson of Data Resources.

At the state level, the outlook may begin to brighten a year or so from now, Ms. Johnson added.

Her firm, she said, is predicting an upturn in 1989, with gnp growth of 3 percent or better.

Vol. 07, Issue 13

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