PHOENIX WOES: The city is facing $241 million more in cuts to make up for revenue decreases. Getty Images THERE'S NOTHING LIKE LOSING SOMETHING to bring home how important it is to you. Right now, local government officials are sorely missing a robust home building market. If new-home building is the engine of the economy, we're getting to see what happens when that engine is up on blocks.

Across the country, cash-strapped city, county, and state governments are scrambling and scrimping to save money, cut costs, and scrape together new revenue to make up for the billions they are collectively losing and expect to lose in the future because home construction is a fraction of its former self.

What's more, it's likely to get harder rather than easier for local governments to adequately replenish their coffers over the next few years as the full impact of the housing collapse and resultant recession hits their balance sheets. Much of their revenue sources lag the economy as a whole by 18 to 24 months.

“Cities face the burden of confronting the effects of the downturn for years after any recession ends,” says Michael A. Pagano, professor at the University of Illinois at Chicago, in a recent research report he helped to compile for the National League of Cities. “This means that cities will be navigating the implications of the downturn for a while longer, even if the business climate turns around immediately.”

The slowing of spending and cutting of costs by governments may set in motion its own hobbling impact on the recovering economy.

Consider these facts and estimates from the National League of Cities:

  • One-eighth of U.S. gross domestic product comes from local and state governments; and
  • Between $56 billion and $83 billion worth of budget shortfalls are expected to affect local governments over the next three years.
  • That translates to estimated job losses of between 1.5 million and 1.6 million in 2010 and 2011, on top of the jobs already cut over the past few years.

    HOW THE DOTS CONNECT The first effects housing's downturn had on local governments were felt by development services departments as permitting, plan review, inspection, and impact fees paid by builders declined.

    While the cliff dive of those revenues—which reflected a two-year peak-to-trough falloff in new-home permits and starts of more than 70 percent in many of these localities—caused job losses within those departments, since they usually operate as self-supported entities, the impact of losing those funds didn't spread much into the general funds of cities and counties.

    It wasn't until 2009 that revenue for cities actually began to fall, decreasing for the first time since 2002. Revenue declined by 0.4 percent even as expenses climbed 2.5 percent.

    By then sales tax revenue began to show weakness, first as builders bought less lumber and drywall and fewer new-home buyers bought couches and curtains. Sales tax took another hit as job losses climbed and unemployed consumers stopped eating out and buying big-screen televisions.

    Lower income tax revenues, caused by lost jobs, also lagged the general slowdown because they are collected in arrears. And then the final hit to government revenue comes as slashed home sales prices begin to translate into lower property tax assessments.

    While cities and counties across the country have had to cut budgets because of the recession, regions where governments became addicted to fast-growing revenue generated by new-home development are coping cold turkey with major withdrawal symptoms. Among all the negative financial feedback loops—where a bad thing causes a series of bad things that ensure that the original bad thing will stay bad or get worse—here was another prime example.

    Like every other stakeholder locked in the complex daisy chain of interdependent interests, municipal, county, and state governments must come to grips with the glaring new-normal reality that they, too, will have to take a haircut—a pretty substantial one, at that—for local, regional, and national economies to regain more solid footing sooner than later.

    Learn more about markets featured in this article: Phoenix, AZ, Los Angeles, CA.