In the States: Fiscal Challenges Continue (Fall 2010 Trust Magazine Article)

Source Organization: The Pew Charitable Trusts

Author: Rita Beamish


11/19/2010 - The weekly holidays for Hawaii’s school children are no more. The kids are back in the classroom this school year five days a week. That’s calmed the uproar that erupted last year when the state ran so short of money that it eliminated Fridays from the school calendar for 17 weeks.

Getting back the full school week did not come cheap, however. It meant raiding the state’s hurricane relief fund to the tune of $57 million, something Governor Linda Lingle had said she would never do, and a move the state insurance commissioner cautioned against. It’s not a matter of whether another massive hurricane will hit the islands, but when, they had said. Now Hawaii will brave that unknown with a much smaller insurance cushion.

Painful tradeoffs and deep cuts, often touching what was once untouchable, such as K-12 education funding. That’s the story these days for many states still facing a long, steep, uphill climb out of the recession. Even though the Great Recession is now deemed officially over, states will face some of their toughest fiscal choices in the coming years, according to research and reporting by the Pew Center on the States.

Federal stimulus money from Washington played a critical role in easing the burden in recent years but now is running out. Costs continue to rise at unsustainable levels in such critical areas as Medicaid, public employee retirement obligations and corrections. Many states were spending more than they were taking in before the recesision and that fundamental imbalance continues. And many states continue to borrow money to pay their bills.

“The challenge for states as they come out of this recession is to look hard at where they spend their dollars so they can be more efficient and deliver better results for citizens both in the short term and the long term,” said Susan Urahn, managing director of the Pew Center on the States. “Fiscal health comes from budget discipline and smart investments in programs that offer strong returns. It takes courage for policy makers to do both of those things, and now is the time.”

Coping with these fiscal challenges has become the defining issue facing the states and so it has become a defining issue for the Washington, DC-based Pew Center on the States. The center is developing a growing portfolio of research, analysis and journalistic reporting that seeks to help policy makers understand how their states got into the current financial crisis and what steps they can take for both immediate and more permanent stability. The center’s researchers and policy analysts undertake original, 50-state assessments that explain how states are faring on particular issues and identify promising policy approaches. The center also collaborates with experienced partners, including the National Conference of State Legislatures, National Governors Association and the Nelson A. Rockefeller Institute of Government.

In addition to its own policy researchers, the center also includes Stateline, a unique team of experienced journalists who track issues and report daily on key budget news and other developments in state capitols. A resource for reporters who cover state houses, the center has developed a following among a bipartisan array of government officials.

Journalist Tom Brokaw cited Pew Center on the States polling when moderating a televised debate in the California governor’s race this fall. And New York lieutenant governor Richard Ravitch, who helped lead his state’s fiscal recovery efforts, has participated in Pew conferences. “The Pew Charitable Trusts, by creating this center on the states, has shown foresight and sensitivity to a public issue of great significance that is now attracting the attention of many other scholars and public policy wonks,” he said.

Over the next couple of years, the center’s staff will be working with a range of partners to examine key issues affecting states’ fiscal health and economic competitiveness. The center’s original research and analysis will focus on states’ revenue systems, public debt, retirement obligations for public employees, transportation costs and other expenditures and the states’ fiscal relationship with the federal government. In addition to the state by state assessments the center has become known for, Pew and its partners will bring leaders from the different states together to discuss common challenges, best practices and the lessons they have learned. Given the fiscal realities facing most states, there is much to do.


HARD TIMES STILL AHEAD

In the earliest days of the Great Recession, Washington poured money into state coffers. Federal stimulus funding amounted to $140 billion and provided enough money to help states fill as much as 40 percent of their projected budget gaps the past two years, according to the Center for Budget and Policy Priorities in Washington.

This past August, Congress provided another $26 billion to the states for education and Medicaid. But that funding is not permanent, and the Government Accountability Office estimates it will run out by July 2011 with little sign, at least for now, that any more aid is coming.

The challenge for state leaders is how to make up for those stimulus dollars—and it is not easy.

In addition to the decline of stimulus funds, states are facing rising costs in a host of areas. The majority of states—44 of them, according to a recent report by the National Governors Association and National Association of State Budget Officers—are operating with smaller general fund budgets than they had two years ago. But most states are expecting to have to spend more on Medicaid, education, infrastructure and other key areas.

The center’s report, The Trillion Dollar Gap, released earlier this year, provided analysis of what it called “perhaps the most daunting” bills coming due for the states—the costs of pensions, health care and other retirement benefits promised their employees. At the end of the 2008 fiscal year, Pew researchers found, there was a $1 trillion gap between the $2.35 trillion states and participating localities had set aside for retiree benefits and the $3.35 trillion price tag of those promises.

The report pulled no punches in its conclusions: “To a significant degree, the $1 trillion gap reflects states’ own policy choices and lack of discipline—failing to make annual payments for pension systems at the levels recommended by their own actuaries; expanding benefits and offering costof- living increases without fully considering their long-term price tag or determining how to pay for them and providing retiree health care without adequately funding it.”

In 2000, slightly more than half the states had fully funded pension systems. By 2008, Pew found that number had plunged to just four states: Florida, New York, Washington and Wisconsin.

The center is developing a new report, for release in spring 2011, calculating the long-term liabilities major cities across the country face in this area and looking at what degree states might be on the financial hook if the cities cannot deliver on their promises.

Meanwhile, Stateline continues to report on states’ efforts to curb the costs of their public sector retiree benefit obligations. A “dozen states have enacted reforms more substantial than those in the past; Illinois raised its retirement age to 67 from 62 for new hires, the highest retirement age in the country. Wyoming started asking current state workers to contribute to their retirement; up to now, the state paid the cost,” reported Stateline’s Stephen Fehr in May.

Corrections is another area where costs are escalating dramatically. States’ general fund dollars for corrections jumped from about $12 billion in the late 1980s to more than $47 billion by 2008. Corrections has been the secondfastest- growing portion of state budgets behind Medicaid; in fact, between 1987 and 2008, its budget totals increased by 303 percent, while state spending for higher education grew by 125 percent, according to Pew research.

But a growing number of states are moving to reduce corrections spending because the increased investment in prisons has not necessarily ensured greater public safety. “State leaders have begun to realize there are researchbased ways they can cut their prison costs while continuing to protect public safety,” said Adam Gelb, director of the center’s Public Safety Performance Project. “In the past few years, a number of states have enacted reforms designed to get taxpayers a better return on their public safety dollars.”

Compounding the challenge of these rising costs have been the severe revenue shortfalls many states have experienced since the recession began in December 2007. State policy makers expect to have closed multiyear budget gaps totaling more than $530 billion “by the time the effects of the recession dissipate,” according to a September report by the National Conference of State Legislatures.

Revenues for most states actually improved in the first two quarters of 2010; gains were widespread, with 34 states showing a small increase in second quarter revenues compared to a year earlier, the Rockefeller Institute reported in October. But the total was still down significantly from peak levels reached in 2008, the institute said. Most experts predict that many states are not likely to see revenues return to their prerecession levels for two or more years.

The fact is, the mismatch between growing expenditures and declining revenues is not new. In a number of states, lawmakers have faced chronic structural deficits—that is, projected expenditures consistently outstripping projected revenues—for years, predating the Great Recession.

Part of the problem, long noted by many budget experts, is that tax systems are out of date and do not adequately reflect states’ current economic activities. This means that even as the national economy recovers and tax revenues increase, many states will continue to see significant gaps between the cost of their services and the amount of money to pay for them.

The center anticipates releasing at least two research reports in 2011 on states’ revenue challenges. One will look at the chronic misalignment between states’ tax systems and their economic activities; another will examine states’ record of success in estimating revenues and the increasingly important stakes involved in getting it right.

One way states have made up for the loss of revenue is to borrow money. Annual borrowing has been growing at an average annual rate of 85 percent from 2000 to 2007. According to federal data, outstanding debt for state and local governments as of 2009 amounted to more than $2.3 trillion—doubling (in real dollars) since 2000. Debt at the state and local level grew 5 percent between 2008 and 2009. Together, Arizona, California, Florida, Illinois and New York held $919.5 billion in outstanding debt in 2008, with California responsible for 37 percent of that total, according to an October 2010 report from Pew and the Public Policy Institute of California, Facing Facts: Public Attitudes and Fiscal Realities in Five Stressed States.

While some taking on debt has always been a part of government spending to finance major capital projects, voters seemed to be concerned about states’ borrowing practices.

The Facing Facts report polled residents of those five states and found them weary of lawmakers passing today’s costs of government on to future generations. Given three choices to balance state budgets, more than two-thirds of residents selected spending cuts first; tax increases were a distant second and borrowing came in dead last.

Over the next year, the Pew Center on the States plans several reports on borrowing practices, from an analysis of trends in state and local municipal debt over time, to a critical look at what debt is being used for, who is issuing the debt and if debt as a financing mechanism is being used to replace other ways of paying for public expenditures.

While some states are beginning to see improvements in their economies and budgets, most are facing a long journey back to fiscal health.

The most prominent national example has been California. In early October, lawmakers in Sacramento approved the fiscal year 2011 budget 100 days after deadline, grappling to close an estimated $19.1 billion deficit. Experts project that the spending plan will produce a shortfall of at least $10 billion in the next fiscal year.

But California is far from alone. In November 2009, the Pew Center on the States published Beyond California: States in Fiscal Peril, a report that pointed out that many other states that faced budget woes with similar problems, including high foreclosure rates, increasing joblessness, loss of state revenues, legal obstacles to balanced budgets and poor money management. The report profiled nine of these: Arizona, Florida, Illinois, Michigan, Nevada, New Jersey, Oregon, Rhode Island and Wisconsin.

The report looked at these state’s fiscal condition as of July 2009. This snapshot captured an important juncture: the first and second quarters of 2009, the pressure point for governors and legislatures in the throes of crafting their budgets for the fiscal year 2010 (which began on July 1, 2009 for all but four states). But a year later, these states and others, such as New York, continue to struggle. For example:

  • Illinois has labored under a legacy of poor fiscal discipline that started well before the recession. Prior to enacting its fiscal year 2010 budget, it was forced to confront a $13.2 billion shortfall. This was nearly half the size of its general fund revenues. Fiscal year 2011 presented additional challenges as lawmakers grappled with a $13.5 billion gap.
  • Nevada faced an unprecedented $3 billion shortfall leading up to its biennial budget for fiscal year 2010 and 2011 after patching together its previous two-year $6.9 billion budget with federal stimulus funds, spending cuts and a sales tax increase. After years of mushrooming growth, Nevada has been walloped by a huge foreclosure rate and downturn in pillars of its economy—tourism and gambling. These factors continue to plague the state: Nevada faced a $1.8 billion budget gap in fiscal year 2011 that was 54 percent of its general fund.
  • New Jersey raised both sales and personal income taxes in recent years but still ended up with one of the nation’s biggest shortfallsin fiscal year 2010, at 30 percent of its general fund revenues. Moody’s Investor Service, citing the state’s budget gaps and chronically underfunded pensions, downgraded the state’s credit outlook from stable to negative in September 2010. Such an action could portend a reduction in the state’s ratings and make borrowing more expensive.
CHALLENGES AND OPPORTUNITIES

Typically, lawmakers consider three choices when balancing their budgets, none of them easy: more cuts, new or higher taxes or deeper borrowing.

Cuts have been seen nearly everywhere. Arizona, with one of the country’s highest foreclosure rates and a 21 percent drop in income and sales tax revenues in fiscal year 2009, slashed dental care, mental health, and other medical services for thousands of people.

Across the continent, Maine slashed education and health services to meet a shortfall of more than $940 million in the fiscal year 2010-2011 biennium budget.

Those reductions translate into real changes for many people’s day to day lives. In Illinois, for example, funding cuts made in the capital in downstate Springfield meant School District U-46 in Elgin, near Chicago, had 330 fewer teachers, fewer elective classes and water in the swimming pool for only one semester. Middle school football and “B” teams in basketball are out. “We can’t keep things that are nice just because they’re nice,” said superintendent Jesse Torres.

There have been tax increases as well. In fiscal year 2010, states raised at least $24 billion in taxes and fees—the largest amount on record. This year, they raised taxes and fees by a more modest $3.3 billion, perhaps influenced in part by the November elections.

While taxes are rarely popular, voters in some states have expressed a willingness to pay more for what they see as important priorities, such as education.

In Oregon earlier this year, voters approved a state income tax increase—the first since the 1930s— that was expected to support education funding and balance the state’s budget. But by May, a new shortfall had materialized. The state instituted acrossthe- board budget cuts of 9 percent that included a $240 million reduction in K-12 education.

In Arizona, lawmakers prepared two budgets, one with and one without a 1 percent sales tax increase. In May, voters overwhelming approved the temporary tax hike. But even with that, the state will be nearly $1 billion short after years of spending more than it took in, said Dennis Hoffman, an economics professor at Arizona State University and revenue forecasting consultant to the state.

Borrowing also continues. Some fiscal experts note that the current low interest rates as well as pressing needs may make it necessary in the short term. But public sentiment appears to be growing against it as a more permanent solution.

Some policy leaders are thinking about more fundamental changes, such as structural reforms that address outdated tax systems that do not match their modern economies. These efforts can face formidable roadblocks.

“If you look at the tax study commissions and efforts legislatures have taken to modernize tax structures, they run into brick walls. These brick walls are made of organized groups that are opposed to any kind of change in the taxes,” said Corina Eckl, director of fiscal affairs for the National Conference of State Legislatures. “Generally speaking the electorate doesn’t like change. They like the devil they know.”

Other state leaders are considering new ways of doing business, in some cases encouraging better uses of technology, that produce a better double bottom line—providing better services at less cost.

“The real pain comes when you don’t do it and a state goes belly up,” said Indiana governor Mitch Daniels. He has steadily reduced the state workforce, ordered most state agencies to trim spending by 25 percent and pared K-12 and higher education budgets.

In an interview, Daniels cited a Fort Wayne school district that recently outsourced its custodial services to a private company, saving more than $4 million a year. “You can use this moment,” he said. “When you turn the spigot off, people do what they should have done decades ago.”

The November elections have more than 6,100 of the nation’s 7,500 legislative seats up for grabs. It is a near certainty that about half of the governors will be new to the office, too. Those officials and their more veteran colleagues face expectations by voters who want more efficient government, reformed budget processes and more prioritized spending.

But Facing Facts highlights a disconnect between what the public wants and what is needed to resolve the states’ fiscal problems.

The report’s poll of five states is an example of that bridge state leaders need to gap. It shows the areas that residents most want to protect from cuts—such as K-12 education and Medicaid. But the report also shows that in those five states many of those same areas account for the biggest spending.

“There are no quick fixes and policy makers will have to make very tough budget decisions to help their states fully recover. They will have to stop funding ineffective programs and channel those investments into approaches that deliver strong returns for the public and drive long term growth,” Urahn said. “In many ways, their hardest decisions are ahead of them.”


Rita Beamish is a California-based journalist and author.

 

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