NEW YORK - New York and New Jersey's economies will likely lag the United States' recovery from its deep recession, due to the importance of the hard-hit financial services sector for the region, economists at the New York Federal Reserve wrote in a report released on Monday.

Large-scale job losses in the financial sector, a steep drop in tax revenues and potentially tighter regulation on pay and the size of financial firms all pose a risk for the region's economic outlook, the economists wrote.

Ongoing bank closures and consolidations suggest that employment in the financial sector may not return to its previous cyclical highs, Jason Bram, James Orr, Robert Rich, Rae Rosen and Joseph Song wrote.

The financial sector can account for as much as 30 percent of all earnings in New York City and job losses in that and related sectors have already contributed to a plunge in state and local tax collections, they wrote.

The tax revenue decline will likely continue and be further fueled by drops in mortgage-related, capital gains and corporate tax collections, they added.

These factors, coupled with the New York-New Jersey region's historical tendency to lag the nation when emerging from recession, point to a period of sluggish activity for the region even as the U.S. economy begins to recovery, they wrote.

The decrease in tax revenues have led to bigger budget gaps, which states and cities usually try to counter through a tax increases and spending cuts, the economists wrote, warning that these are measures that can crimp regional economic activity.

Future regulatory changes in the financial sector could also limit lines of business, pay structure, and size of firms. The form, shape and timing of these forces are unknown, but they certainly have the potential to dramatically reshape this sector and play an important role in the region's recovery -- particularly New York City's, the economists wrote.

(Reporting by Kristina Cooke)

New York New Jersey