Rising healthcare costs, underfunded pensions, neglected infrastructure needs, eroding tax revenues and expected federal budget cuts add up to a rapidly deteriorating trend on course for fiscal disaster, said the report by a group called the State Budget Crisis Task Force.
"The existing trajectory of state spending, taxation and administrative practices cannot be sustained," task force co-chairman Richard Ravitch, a former New York lieutenant governor, told a Washington news conference. "The basic problem is not cyclical, it is structural."
"Our essential goal is to inform the public of the gravity of the issues and the consequences of continuing to postpone actions to achieve structural balance," co-chairman and former Federal Reserve Chairman Paul Volcker said.
Ravitch, a Democrat credited with helping rescue New York City from financial collapse in the mid 1970s, added: "Our goal was not to say that the apocalypse is around the corner. But it will be a hell of a lot more expensive to deal with these problems in five or 10 years than to deal with them now."
The task force analyzed California, Illinois, New Jersey, New York, Texas and Virginia and found the severity of states' long-term problems is often masked by lenient state budget laws and dubious accounting practices that permit "gimmicks" to solve short-term cash needs and appear to balance budgets.
California, for instance, borrowed money several times during the past decade to generate budget cash, the report said. New York delayed paying income-tax refunds to push the costs into the next fiscal year, while Texas delayed $2 billion in payments to accomplish the same end.
New Jersey borrowed against money it received from the Tobacco Master Settlement Agreement. That state and Virginia both failed to make required payments to their pension funds, while Illinois, which has billions of dollars of unpaid bills, borrowed heavily to invest in its severely underfunded pension funds.
All told, pension funds for state and local governments are underfunded by about $3 trillion, using conservative investment assumptions, the report said, and healthcare liabilities for public-sector retirees top $1 trillion.
"The ability of the states to meet their obligations to public employees, to creditors and most critically to the education and well-being of their citizens is threatened," the chairmen warned.
States don't have enough money to cover the health and retirement benefits they owe state workers, they're losing billions in sales tax to Internet sales -- the consumer economy itself is shifting from buying goods to buying less-taxed services, the report said.
Gasoline tax revenues have not kept up with urgent infrastructure needs, the report said. And distressed cities and counties pose increasingly demanding challenges to states.
As a result, states are being forced to show a "willingness to 'unbuild' state government in a way that has not been done before," the report said.
Ravitch said efforts to reduce the federal deficit could result in cuts at the state level that aren't being properly considered.
If federal grants to states were cut by just 10 percent, the loss to state and local government budgets would be more than $60 billion a year, the report calculated. That would be nearly twice the size of the combined tax increases states enacted from 2008 to 2011, it said.