This article is a followup to my earlier post titled Why Are So Many U.S. States Facing Budget Deficits? which generated some interesting comments from Seeking Alpha readers. In addition to fall in property, income, sales tax revenues and rise in social benefits spending some readers pointed out that the main culprits are the compensation of government employees and the reckless spending of states without saving funds for rainy days during good times. In this post I shall analyze these two additional causes with charts.

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Data Source: Table 3.10.5. Government Consumption Expenditures and General Government Gross Output, BEA

By far, the main reason for budget deficits seems to be government expenditure on employees compensation. The chart above shows that state and local employees are getting compensated more than their federal peers.

The Federal Government spent 43.3% of its consumption expenditures on employees wages and benefits in 2008. After 1979 this ratio always stayed under 50%.

69.5% of State and Local government’s expenditure in 2008 went towards workers compensation. This ratio is very high. In 1999, this ratio was 73.7%. While it has reduced slightly in the past few years, it is still a major cause of concern.In order to offer such high compensation to workers, state and local governments have raised taxes and other fees over the past few years. In addition, Michael Mandel of Business recently noted that 2.4 million jobs were created by the public sector in the past 10 years as of May 2009.This implies that more workers added in the public sector in the past decade and the government expenditure on compensation stayed in the 70s range. Adding more workers to the already highly-paid workforce probably exacerbated the deficit problem. In 2008, compensation amounted to over $1 Trillion of the $1.4T consumption expenditure.

The following chart shows the Net Savings ratio as a factor of current receipts. This is the measure of how much funds the government saves after all the expenditures are subtracted from the current receipts (revenues) amount.

Data Source: Table 3.2. Federal Government Current Receipts and Expenditures,
Table 3.3. State and Local Government Current Receipts and Expenditures, BEA 

Governments are supposed to save during good by reining down on unnecessary expenses and saving for future rainy days. This ratio has always been worse at the federal level while at the state level it can be considered just marginally better. The chart shows that since 1970 the feds have been running deficits except for a four years in late 90s. From 1998 thru 2001 during the Clinton Administration the federal government had a budget surplus.From 2001 thru last year the federal government had been borrowing year after year. Last year the Net Savings amount for the federal government was -525B, the highest figure in recent years.

Have you ever wondered how much the U.S. Federal Government spends on the various social benefit programs?. My analysis shows that federal spending on social benefits is rising fast.

Source: Flow of Funds Accounts of the United States report, 1Q-2009  & BEA NIPA tables
Data for 2009 is for the first quarter annualized.

The huge spike in the early 1930s is due to the New Deal program that was implemented. Federal social spending has been increasing overall since 1945. In 1945  it was about 10%. This year social spending will account for 62.6% of federal government’s receipts (revenues). From a recent of low of 44.8% in 2005, the figure has been steadily increasing each year and reached 62.6% now. This is unprecedented since the last time social spending reached very high levels was in 1931 at 89.5% – which was the all-time high.

The high social spending by the Feds shows the severity of the current recession. As unemployment rises more and more folks depend on the government welfare programs such as unemployment insurance, medicaid, etc. for survival. In the long-term this is not good for the economy as more resources of the federal government goes into supporting programs which were originally created to be used as a stopgap temporary arrangement to be used as a last resort.But due to the recession and rising unemployment levels, people who are unemployed are using the most of all government social benefits. This is evident from the rising exhaustion rate of those receiving unemployment insurance. The exhaustion rate measures the number of those unemployment insurance beneficiaries who run out of their maximum allowance.This number stood at 49.23  (US totals) for the month May according to the Department of Labor data.

If the current receipts of the federal government continues to go down  and the social benefits spending increases continually over the next few quarters, then the feds will borrow more to fund the gap causing the budget deficit to go higher.

Many states in the U.S. are facing budget deficits this year. According to one estimate states collectively will face an estimated $80 B in deficits. California is one of the states with a huge budget shortfall. Today the rating agency Fitch downgraded California to A-minus and is just eight days away from issuing IOUs unless lawmakers solve the crisis.

The following are some examples of budget deficit news headlines:

• Strickland: Ohio facing $7 billion deficit 
• Michigan’s budget deficit gets deeper
• Florida faces $1.5 billion budget deficit
• State budget deficit grown to $12.5B, says Paterson
• Arizona Budget Deficit Worst in the United States

Faced with the shortfall many states are cutting services  and increasing fees on items such as auto licenses, title, registration,  etc. Some local governments are adding traffic red light cameras to catch speeders and generate additional revenue. One of the worst fees that is becoming popular is the so-called “crash tax” , which is basically fees charged for fire and police response when a person is involved in an accident. The logic behind this is that if one is involved in an accident he/she has to pay for the emergency services they receive. Mostly this fee is charged to the insurance carrier. However in some cases the drivers who caused the accident  have been sent the bill.

I wanted to find out why many states are facing budget shortfalls now. The following graphs are the result of my analysis.

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The above chart shows that since mid-2006 the state and local government social benefits spending as a percentage of  current receipts  has been increasing consistently while all four main type of tax revenues have been either flat to down or went up very slightly. Income, Sales, Property and Taxes on corporate income have all been below social spending in 2008. Sales tax revenues and corporate tax incomes are on a downward slope due to the current recession. Property taxes for all states have stayed in the 20% range since 2002. Higher unemployment rates projected for the rest of this year will push social spending higher and cause other tax revenues to fall.

A historical graph of the state and local revenues and social spending is shown below. This chart also shows that social spending as a percentage of current receipts has increased over the years.

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There are other causes of budget deficits that are not addressed in the analysis. Some of them include reckless spending on wasteful projects, high salaries paid out to current government employees, liberal retirement,health care benefits offered to retired workers, etc.