State Governments Growing in Reverse, Report Finds

For the first time since 1983, state government spending is expected to shrink from one fiscal year to the next, with 19 states predicting negative growth in state government for the fiscal year that begins July 1, according to a report released Thursday.

The primary cause of this retrenchment in state spending, which is based on governors' proposed budgets for 2004, is lagging tax revenues, says the new report from the National Association of State Budget Officers (NASBO) and the National Governors Association (NGA).

One consequence of the revenue shrinkage is that lawmakers are cutting nearly every area of state government, including K-12 education, Medicaid, higher education, state police, prisons and aid to towns and cities.

Also, in order to stem fiscal bleeding and protect state programs, many states are turning to tax and fee increases, with governors in 29 states proposing $17.5 billion in revenue increases. If enacted, this would be the largest total state tax increase since 1979, the report says.

These two options, program cuts and tax increases, are just about the only choices cash-strapped states have left, because most of them have depleted their reserve funds over the past two years in addition to borrowing money at near record-high levels.

Ray Scheppach, executive director of the NGA, said no program better demonstrates the tough choices states face than Medicaid, the state-federal program that provides healthcare to 47 million disabled and low-income Americans.

"It is now becoming, we would argue, the Pac-Man of state government. Which means it is eating up each additional dollar that can be generated in revenues," Scheppach said at a press conference announcing the new report.

Medicaid now consumes roughly 20 percent of state revenues and is growing far faster than most states' ability to pay for it. To control the program's costs, many states are saving money by cutting dental benefits or kicking people off the rolls.

"The reality is that poor women and children are either experiencing a reduction in benefits or are being removed from the rolls altogether. . . .It is a simple reality a governor has to make cuts to the program in order to balance the state's budget. If enrollment rates go up and drug costs go up, then the only way to afford the program is to cover fewer people. For most governors, these difficult choices have become a daily reality," Scheppach said.

In addition to scaling-back Medicaid benefits, governors are seeking flexibility from the federal government to more radically change how the program operates. President Bush proposed a plan in February that would have granted this, but many governors balked at the proposal's cap on federal spending, which they say would have transferred too much financial risk to state governments. Analysts say Bush's proposal is unlikely to find much support on Capitol Hill without the backing of a strong majority of governors.

Scheppach said it is essential that governors, the Bush administration and Congress come together to find a way to control the program's costs.

"It is huge. The governors were not able to agree. My sense is that we're kind of at a hiatus and we're going to have to come back to the table again. . . .It doesn't matter whether states continue to downsize or continue to rework their tax systems; we're not out of this long-run problem unless we also reform Medicaid," he said.

The federal government recently sent states $10 billion to shore-up Medicaid and forestall some of the program's most egregious cuts, but few state officials see that as anything but a short-term fix.

Beyond the upward pressure Medicaid is placing on state budgets, many governors and state legislators are contending with the most severe drop in state revenues since WWII, Scheppach said.

The drop first became apparent late in fiscal year 2001. It started in the manufacturing states of the Midwest and Southeast, but has been most severe in Northeastern and the far West states, such as Massachusetts and California. These states depend heavily on tax revenues from high-income individuals and capital gains. As a result, the bursting of the stock market bubble led to a severe bust in their fiscal prospects.

The Nelson A. Rockefeller Institute of Government reported Thursday that state tax revenue rose 1.4 percent in the Jan.-March quarter of this year compared to the same quarter last year. Rockefeller says the slight rise is due mostly to tax increases states enacted last year.

Minus the legislated tax changes and after accounting for inflation, revenue in the Jan.-March quarter declined 3.4 percent, according to Rockefeller, which is the seventh straight quarter of adjusted revenue declines.

"The net effect is that most states are losing ground on revenue even before we factor in population growth and the demand that generates for additional government services," said Nick Jenny, a policy analyst at Rockefeller.

States hoping for a significant rebound in their tax revenues may be left wanting, said Scheppach. In fact, Scheppach said he expects revenues to continue to lag, meaning that states will be making even more cuts to the budgets they've already passed.

"Revenues have not turned around yet, and therefore my own feeling is over the next 6 months, you're probably going to see states cuts another $5 to $10 billion," he said.

Ongoing uncertainty in Maryland's fiscal situation led Gov. Bob Ehrlich (R) to withhold Thursday more than $600 million that agencies had been expecting to receive beginning July 1, according to news reports. This move could force layoffs in nearly every agency and cut some services up to 10 percent.