The start of the federal fiscal year was changed from July 1 to Oct. 1 when the Congressional Budget Act was signed into law in 1974. This was a momentous change for federal budget policymakers who had to figure out what to do with the “transition quarter” — the three months between the end of the old fiscal 1976 and the beginning of the new fiscal 1977. But the new start date meant little for the states, and few changed their fiscal year as the federal government did. As a result, in about three weeks, fiscal 2011 will begin in 46 states.

[IMGCAP(1)]The start of the states’ new fiscal year is usually the prototypical example of something that isn’t news or even worthy of commentary. It’s a routine event roughly equivalent in news value to the arrival of new telephone books. The start of the fiscal year in the states seldom makes headlines or even generates stories below the weather map on the last page of the local section of a newspaper.

This year will different: The changes coming in state budgets in fiscal 2011 will have a substantial negative effect on the U.S. economy as a whole. According to an analysis by the National Conference of State Legislatures, in 2011 all 50 states and Puerto Rico are facing an almost
$90 billion budget gap.

As a result, they either will be cutting spending and, therefore, buying less, or increasing revenues and reducing the spending that businesses and consumers otherwise would have done with at least some of those funds. Therefore, not only are state budgets not likely to provide any overall economic stimulus next year as the economy continues to recover, they will be doing the opposite by decreasing the gross domestic product.

This is not just a one-year situation. The NCSL analysis shows that 31 states are already projecting significant budget gaps for fiscal 2012: 18 are estimating that the gap will be 10 percent or higher. Six of those states estimate that the gap will be more than 20 percent.

Government spending at all levels is one of the standard components of what is used to determine the GDP, so making an assessment about what the states are doing is always built in to the federal budget process to some extent. But this year will be anything but a normal year.

The magnitude of the coming budget changes by the states, the very apparently growing presumption that the federal deficit needs to start being reduced substantially and the remaining questions about the economy make it more important than usual that what the states are doing gets taken into account as federal budget policy is determined.

The projected state budget gaps are the result of a variety of factors, including economy-induced lower revenues and an assumed discontinuation in federal stimulus dollars. Many states have already planned or taken significant actions, from the hard-to-imagine (releasing prisoners early from state jails) to the merely annoying (shuttering bathrooms on major interstate highways).

But given the NCSL-reported budget gap that the states are facing, whatever has been done or contemplated so far will not be the end of the story. In fact, what the federal government does to reduce its deficit will likely make things even worse because almost any package of federal spending cuts will have to hit state budgets hard.

The reason is that, from homeland security to health care, and including both appropriations and entitlements, much of what the federal government does is provide aid to state and local governments. The Obama fiscal 2011 budget, for example, listed more than $1 trillion, that is, more than a quarter of all spending, in this category. Therefore, spending cuts in Washington to reduce the deficit will make what’s already a hard situation for the states worse and will force them to consider additional changes that will reduce the GDP further.

This is going to create two big federal budget problems.

First, more than has been the case in the past, federal fiscal policy will have to be considered in the context of what the states have no choice but do next year because of their balanced budget requirements. Concerns about federal actions to ward off inflation and higher interest rates because of the federal deficit will need to be tempered because state budget actions to close their $90 billion gap will already be doing some of what fiscal policy will be expected to do. Not taking the state actions into account will mean that economic growth and the number of jobs created will be far less than anticipated and needed.

Second, beyond taking the state actions into account, an effort will have to be made to do something that has seldom, if ever, been done before during a federal budget debate: include the effect of state government budget actions in the public discussion. Without that type of understanding, the amount of federal deficit reduction that is economically justified is likely to be demonized for political reasons as being too modest. That would create a fiscal policy that is not just inappropriate but actually harmful.

Stan Collender is a partner at Qorvis Communications and founder of the blog Capital Gains and Games. He is also the author of “The Guide to the Federal Budget.”