Five months ago, Winnipeg-based New Flyer Industries was touted by governments as a poster child for stimulus spending.

Now it's handing out pink slips and idling plants.

The bus maker was poised to start production of 140 diesel-electric hybrid buses for the Chicago Transit Authority in the final week of July. But Illinois is strapped for money and the order, supposed to be delivered in the second half of 2009, has been deferred "indefinitely."

Illinois's cash crunch, and its impact on a Canadian manufacturer, highlights one of the risks to the North American economic recovery. The U.S. government has attempted to stimulate the economy with an unprecedented flood of cash, and its spending has been credited with helping to avert a depression. But now, as state and local governments find their revenues falling far short of projections, they're forced to slash program and capital expenses nonetheless.

These government cutbacks could erode some of the benefits of the $787-billion (U.S.) stimulus bill, economists warn.

"States are facing an incredible drop in revenues, given how much the economy has slowed and pressure to balance the books, and that is going to limit the stimulus from having the effect we might think," said James Marple, a Toronto-Dominion Bank economist.

"About one-third of the federal stimulus is being offset by the acute restraint at the state and local government level," said David Rosenberg, chief economist at Gluskin Sheff.

At least 34 states already anticipate deficits in 2011, and combined budget gaps for the next two years are estimated to total at least $350-billion (U.S.), according to the Washington-based Center on Budget and Policy Priorities.

Beyond stimulus money, states are looking at budget cuts and tax increases to mitigate those gaps (most states are not allowed to run a deficit). Arizona, California, Nevada and Illinois are among the states that had the worst budget gaps as the crisis ensued.

But many states' finances were already in a precarious position before the stimulus bill passed, which is why $144-billion was directed straight to state and local relief, notes Paul Ferley, assistant chief economist at Royal Bank of Canada. That amount, however, is not enough to fill the gaps.

While more than 30 states have already taken measures to cut services, "there's a lot more that has to be done," said Justin Hoogendoom, a managing director in Bank of Montreal's Chicago-based fixed income group. "It's a combination of increased taxes and cuts in spending in order to fill that budget gap."

Several industries are already suffering as a result of cutbacks by U.S. governments. American LaFrance, a South Carolina-based company that makes fire trucks and emergency vehicles, filed for bankruptcy protection last year, in large part because of crimped municipal budgets (it has since restructured and emerged from bankruptcy). Companies catering to the education system, parts of the health-care system, government workers and social systems are also feeling the pinch. Many businesses will feel the effects of higher taxes.

The hope is that stimulus funds will help carry states through to a point where the financial markets are functioning better and balance sheets have improved, allowing the private sector to step in, Mr. Ferley noted.

But, with tax revenues falling more than expected as a result of the recession, many economists feel that's increasingly unlikely.

"There are real risks that we just go back to an underlying state of weakness, which is where that risk of a double dip recession comes from," Mr. Marple said.

There's more than a little irony to New Flyer's story: In March, U.S. Vice-President Joe Biden hosted a forum about Washington's new stimulus legislation at a New Flyer plant in Minnesota. He singled out the bus maker as an example of a company that could benefit from new funding for public transportation. The same week, Export Development Canada, the federal government's export credit agency, chose New Flyer as the first financing recipient under its new powers to support domestic companies and boost the flow of credit.

Only a few weeks later, the Chicago Transit Authority sealed a deal to buy 58 hybrid buses from New Flyer using stimulus money.

But that order was only a drop in the bucket for Chicago's aging bus fleet. More than 300 of Chicago's 2,200 buses date to 1995 and they've clocked an average of more than 450,000 miles each, Carole Brown, chairwoman of the Chicago Transit Authority, said in testimony to the U.S. Senate this month. "These buses have travelled the distance from the Earth to the moon - and back."

The transit authority had a pending contract for another 140 New Flyer buses, worth $122.7-million. It wasn't necessarily seeking stimulus funds to pay for that one, but it was hoping for state financing that hasn't come through, and so the order is on ice until funding can be found. As a result, New Flyer is cutting about 320 jobs, or 13 per cent of its work force, and plans to shut its plants in Winnipeg and Minnesota during the last two weeks of the year.

Besides Chicago, the bus maker has received orders from Philadelphia, Rochester, Milwaukee and the University of California for buses that would be paid for, either in part or in entirety, with stimulus funds. No order besides Chicago's has been shelved, chief executive Paul Soubry said.

The situation illustrates the problems with stimulus spending, said John Tillman, chief executive of the Illinois Policy Institute, a public policy organization with a free-market bent.

"It would have been much better to do spending reforms and tax cuts to put the money back into the private sector," he said.

"The reason a state like Illinois has a problem is because we spent our revenues at a record rate prior to the economic slowdown."

Spending was up 39 per cent after inflation from 1998 to 2008, Mr. Tillman said.

"So when revenues slow down that creates a deficit situation and tremendous pressure to go for a tax increase, which kills the recovery."