In the past few years, states and cities have had to make unprecedented budget cuts as revenues tumbled with the economic downturn — but the worst is still to come. At GOVERNING's Annual Outlook in the States and Localities conference convened in Washington this week, everyone seemed to agree on one thing: Even as the national economy begins to turn around, 2012 will be the worst budget year for states and cities so far.

State revenue receipts are down 12 percent from their pre-recession peak, and states have already sliced a combined $430 billion from the 2009, 2010 and 2011 budgets. While the majority of states aren't facing budget gaps for the current year, the looming loss of federal funds through the American Recovery and Reinvestment Act means that most states are projecting major revenue gaps for next year. When stimulus dollars run out in June, that's over $150 billion in flexible funds that will no longer be at states' disposal. "We're going to see austere state budgets for the next several years," said Scott Pattison, executive director of the National Association of State Budget Officers. After outright declines in state spending over the past two years, sales tax and income tax revenues will rebound in 2011 and 2012, Pattison said. "But it won't be enough new growth to make up for the loss of the stimulus funds and the rising costs of health care."

Exacerabating the problem is the fact that states have already spent the past few years enacting bleeding-edge cuts to discretionary programs. "The low-hanging fruit is gone," Pattison said. "Even the medium high-hanging fruit is gone. So the pain is going to be worse, even though the data may start looking better."

Others at the Outlook conference took an even more dire view. John Thomasian, director of the Center for Best Practices at the National Governors Association, said he believes it will be 2013 before state revenues are back up to 2008 levels. But in terms of being on solid fiscal ground, states are in for several years of pain. "When will we be back to normal? By the end of the decade. And even then it won't be the old normal."

One bright spot of optimism came from Maryland Gov. Martin O'Malley, who discussed the ways that a dedicated focus on performance measurement has helped his state weather the fiscal storm better than most. In this time of economic uncertainty, O'Malley said, "openly measuring the performance of our public institutions, and communicating that performance to citizens, has never been more important." States that blindly react to the downturn with across-the-board cuts won't ultimately be successful, he said. "The states that win will be the states that [...] manage for results."

Maryland hasn't been spared any tough fiscal choices. O'Malley has cut $5.6 billion from the state budget in the past four years, and is set to cut another billion dollars by the end of this year. He's eliminated 4,200 positions in the state and will trim even more this year through early-retirement incentives. He's raised taxes on sales and on corporate income. But, O'Malley said, focusing on hard data has helped him decide how to allocate the state's ever more limited resources. As an example, his pointed to Maryland's BayStat program, a data dashboard that tracks sources of pollution into the Chesapeake Bay. In the past, the state has relied on broad 20-year plans to clean up the bay — which he said ultimately didn't have much effect. Today, Maryland can track the source of runoff pollution, county-by-county, in nearly real time. It's helped pushed the bay to its cleanest levels in seven years, and BayStat is now being replicated by other states in the Chesapeake Bay watershed, as well as the federal Environmental Protection Agency.