Democratic Governors Seek $50 Billion in Aid

Bush's Economic Plan Would Make States' Fiscal Crises Worse, Officials Say

The nation's Democratic governors appealed to Washington yesterday for $50 billion in aid to their cash-strapped states, castigating President Bush's new economic plan as a blow to state governments reeling from their worst fiscal crises in 50 years.

The Democratic governors' appeal came in the form of their $157 billion economic stimulus proposal. It included $75 billion in tax cuts, mainly in the form of $375 tax rebates; $13 billion for school and road construction and homeland security needs; $19 billion for unemployed workers and low-income seniors; and $50 billion in direct aid to the states.

That proposal must compete with the president's 10-year, $674 billion growth plan and a host of smaller proposals from congressional Democrats.

But at the very least, the governors said, Congress should not enact any proposal that would make the states' fiscal crises worse, as they contend Bush's proposal would. "We have to avoid any policies that exacerbate the problems of the states," said Washington Gov. Gary Locke, chairman of the Democratic Governors Association.

As late as Monday morning, the nation's governors were assured that the president's plan would include $6 billion in state aid. But the provision was dropped in the final package.

What remained could cost the states billions of dollars in tax revenue and increased interest payments, state finance experts said. Bush's proposal to end taxation of investment dividends would cost state governments $4 billion this year and $45 billion to $50 billion over the next decade, said Harley Duncan, executive director of the Federation of Tax Administrators, which represents state finance officials.

That is because states tax dividends, using federal tax forms. If the federal government eliminates dividend taxation, the states may have to follow suit, Iowa Gov. Tom Vilsack said.

Potentially more damaging would be the impact the Bush plan may have on state-issued bonds. State and municipal governments can offer relatively low interest rates on their bonds because the bonds' tax-exempt status is attractive to buyers. But if dividend-paying stocks become largely tax-free, state governments would have to offer higher interest rates on the bonds to keep investors from shifting their money into the stock market. That would raise the cost of building schools, roads, sewer lines and any other state responsibility. "There are deep concerns that this might increase the cost of borrowing," Vilsack said.

Thomas C. Grzymala, president of Alexandria Financial Associates, a Washington area financial advice firm, said the Bush plan would make tax-exempt state bonds "lose a little of their luster."

The White House has defended its decision, saying the president's proposal would help the states by buoying the economy. Bush's "judgment was the best use of scarce federal dollars would be to stimulate and grow the economy and not transfer tax dollars from one taxpayer-funded government entity to another government entity," White House spokesman Ari Fleischer said yesterday.

But Mississippi Gov. Ronnie Musgrove said the economy will not recover as long as deficit-ridden state governments continue to cut spending and raise taxes. That sentiment is not exclusively Democratic.

"Given that 49 of the 50 states have balanced-budget requirements, it does not matter whether states reduce spending or increase taxes -- their actions will be a drag on economic recovery," the bipartisan National Governors Association said in a statement Tuesday. "The most powerful immediate economic stimulus the administration could have recommended would have been to provide assistance to states to forestall planned spending reductions and tax increases."

The timing of the Bush proposal could not be worse, said Iris Lav, an economist at the liberal Center for Budget and Policy Priorities. The states are facing budget deficits totaling $60 billion to $70 billion next year that, by law, they must close through spending cuts and tax increases. Even a modest hit to state coffers will likely mean cuts to education, health insurance for the poor and other state government responsibilities. In the current situation, "every dollar counts," Lav said.

The impact on the states could also provide ammunition to opponents of Bush's plan, who say the proposal will hurt the impoverished beneficiaries of state programs even as it helps affluent taxpayers through the dividend tax cut and income tax cuts.

Micah Green, president of the Bond Market Association, cautioned that it is too early to predict how much states will have to pay higher interest rates on their bonds. Such bonds attract buyers not just because of their tax-free status but because they have defined interest payments and are often guaranteed. No matter how generous Bush's plan is to issuers of stock, equity markets will never be as safe, he said.

But, he added, in the coming congressional battle over Bush's plan, bond traders will be fighting to maintain some advantage for municipal and state bonds.