Budget squeeze sours jobs picture

By Colin Barr, senior writer

NEW YORK (Fortune) -- Another big employer is hanging out the "Not Hiring" sign.

State and local governments are collectively the nation's biggest source of jobs, together employing almost 15 times as many Americans as Wal-Mart (WMT, Fortune 500).

They added 2 million jobs over the past decade and helped to cushion the shock of the Great Recession by holding employment steady since the end of 2007, a time when the private sector was hemorrhaging 8.5 million jobs.

But another ugly state budget season is coming up, which will mean more belt-tightening for local governments -- and another source of pressure for an already anemic jobs market recovery.

State tax revenue dropped a record 11% in the year ended in September, the Center for Budget and Policy Priorities estimated this week. New taxes and fees will raise less than half that amount.

Estimates of state budget gaps over the next two years, both open and already filled, reach into the hundreds of billions of dollars.

The squeeze will prompt more municipalities to freeze hiring, cut benefits and in some cases resort to layoffs.

"We're at the point where elected officials and budget forecasters are fully aware of how bad things are," said Chris Dixon of Input, a Reston, Va., government-market research company. "Right now they're buying time for revenue growth to resume."

Layoffs aren't the first choice of governments seeking to balance their budgets. A survey conducted late last year by the Center for State and Local Government Excellence found two-thirds of respondents had stopped hiring and almost as many had put a freeze on raises. Less than half had resorted to job cuts, however.

But the size of budget shortfalls is making cuts inevitable. A thousand state workers in South Carolina could lose their jobs if the legislature enacts a pending budget proposal, the Columbia State reported. Cutbacks are pending in Virginia, Georgia and many other states.

Some of the cuts will be averted as lawmakers shift funding priorities and paper over some budget shortfalls with one-time maneuvers. Some officials will defer the most painful decisions until after November's elections.

"The politics of an election year probably mean we're looking at another year of kicking the can down the road," Dixon said.

But revenue in most regions isn't expected to recover to its pre-recession level until mid-decade. Municipal officials will also face numerous challenges in the next few months.

End of big spending in Washington?

First, there's the timing of federal stimulus funding. As hard as state and local government budgets have been hit by the downturn of 2008 and 2009, that pain has been eased by federal funding for unemployment insurance, Medicaid and other programs. Some of these programs are set to end later this year.

The federal government will also soon pull back on its massive support for the housing market, which has aided municipalities by slowing the decline in house prices and pulling the economy out of free fall. The Federal Reserve is due to end its purchase of mortgage-related bonds this month. That could cause interest rates to rise.

And officials around the country are still struggling to get a handle on their pension problems, which may pressure finances for years to come.

Municipal job cuts alone won't likely make much of an impact on the headline unemployment number. But they could dampen the recovery in consumer spending that is crucial for the growth of small businesses, which are typically responsible for much of the nation's jobs growth.

A pullback would be especially damaging now because a third of small business owners say their biggest problem is weak sales, according to February data from the National Federation of Independent Business. That's the highest reading on record.

"Profits trends are terrible, undermining owners' ability to finance any aspect of growth," the NFIB said in its monthly report. To top of page