The Next Big Crisis

It's a lagging indicator's lagging indicator, and one that could give the economy a kick in the shins just as it's getting back on its feet. Even though growth is picking up and the nation could add jobs as early as this spring, many cities and states won't hit financial bottom until as much as three years from now, which will add thousands to unemployment rolls and slow the recovery locally.

Since local governments get most of their money from income and property taxes, high unemployment and precipitous drops in real estate values take a large bite out of revenue, but there is typically a lag of between one and three years as taxes are collected on the previous year's income and property values are reassessed. And unlike the federal government, which can help to drive growth by running deficits, most state and local budgets are required to balance their budgets, meaning that layoffs, steep cuts in public services, or tax increases could be on the horizon nationwide.

"I think this is one of those sleeper issues—essentially these shortfalls will translate into 'anti-stimulus'," says Ethan Pollack, a policy analyst at the Economic Policy Institute, who estimates the combined shortfalls for state and local governments at $469 billion over the next three fiscal years. "At the best, that can lead to a protracted, slow, jobless recovery, and at the worst, a double-dip recession."

The beginnings of that wave are being felt in places like Bossier City, La., a town of about 65,000 across the Red River from Shreveport. Facing a deficit of about $6.5 million in its operating budget, Bossier City passed a 2010 budget this month that cuts 80 positions—including 45 posts in the fire and police departments—and institutes a 15 percent reduction in operating expenses across departments. (The actual number of laid-off workers is 46, because many of the eliminated positions were vacant.)

The cuts were controversial in the city, with citizens filling council meetings, and some city officials spoke out against the layoffs. "Unfortunately, the city's got to take this sort of action in order to balance the budget," says city spokesman Mark Natale. "It's certainly a hard decision, but like many entities, city government isn't immune to budget cuts."

Other cities are going to have to make similar painful cuts. Because previous downturns were less severe, governments were able to make up for shortfalls by trimming around the edges and cutting down on less-essential services. Now, like Bossier City, some cash-strapped cities are even cutting down on usually sacrosanct police and fire services. "There are some questions for communities out there about what they want their community to look like," says Chris Hoene, director of research at the National League of Cities. "Should the city provide just public safety, or are they concerned about quality-of-life issues? You're looking at having libraries, schools, and city governments that are only open four days per week."