Susan K. Urahn on States’ Ongoing Fiscal Stress

Dec 18, 2008

Susan K. Urahn
Managing Director, Pew Center on the States

States’ budgets have weakened further as the economy has fallen nationwide. Here, Susan Urahn, managing director of the Pew Center on the States, updates the financial challenges facing state policy makers.

Questions and Answers

Question
Recent news reports paint a grim economic picture of states’ budgets. Are they in as much trouble as they seem?


Answer
State policy makers knew this year was going to be difficult. Six months ago, they cut almost $50 billion to balance their 2009 budgets. But the situation has been even worse than they anticipated. Tax revenues have plunged at the same time demands such as growing unemployment rolls are pressuring state budgets. Midyear budget deficits of more than $30 billion have opened in at least 37 states, according to the Center on Budget and Policy Priorities. And as we’ve grown accustomed to hearing, the situation will likely get worse before it gets better. The National Governors Association recently estimated that states’ combined 2009 and 2010 budget deficits could hit $200 billion. States will likely struggle to balance their budgets into 2011.

Question
Which states have been hit hardest by the economic downturn?

Answer
Nearly every state has been affected. Tax receipts of all kinds are declining. Sales taxes are slowing as consumers buy less; corporate and personal income taxes are falling as companies earn less and increase layoffs. The stock market’s decline has erased capital gains that might have been taxed, and even lottery revenues are down in a number of states.

This has been a hard and fast fall for many states. States that rely heavily on residential construction and real estate taxes, including Arizona, Florida and Nevada, felt the economic downturn earlier than most and are now grappling with some of the largest budget holes. Florida’s deficit grew by $150 million in a matter of weeks, to $2.3 billion, while Arizona and Nevada face double-digit gaps.

Meanwhile, financial services losses continue to ripple through the Northeast. New York’s budget gap for the remainder of this year and next is more than $15 billion, and Massachusetts reported in mid-December that its 2009 deficit has grown by $750 million in just two months and now stands at $2.1 billion.

No description of the severity of this crisis is complete without discussing California. The state’s budget deficit for this year and next is now estimated at more than $40 billion, enough to lead Governor Arnold Schwarzenegger to declare the state on the brink of “financial armageddon.” Standard and Poor’s lowered the state’s short-term bond rating and has put it on watch for a downgrade of its long-term rating as well.

Question
Will the federal government help the states pay their bills through a stimulus package?

Answer
President-elect Obama met with the governors in Philadelphia in early December and signaled his interest in including fiscal support for states in the potential federal stimulus package. That funding is likely to come in the form of increased funding for Medicaid, unemployment benefits and food stamps—three programs whose enrollments grow during times of fiscal stress—and state infrastructure projects, from road and bridge repair to extension of broadband to rural areas. 

In 2003, during the last recession, the federal government delivered $20 billion in aid to states.
 
Question
How are states responding to their budget problems?

Answer
The magnitude of the budget gaps, and the short time within which they’ve opened, has put pressure on state policy makers to act quickly. Within days of identifying sizable deficits in the last several months, states including Michigan, Virginia and Massachusetts announced significant spending cuts, employee layoffs and withdrawals from their rainy day funds. It is important to remember that these efforts are aimed at moving targets. The deficits continue to grow larger as revenues fall below estimates, and increasing numbers of unemployed residents are boosting demands for unemployment insurance and health care spending.

By early December, at least 10 states had already implemented across-the-board budget cuts, and another 10 were considering them, according to the National Conference of State Legislatures. 

Many states also have acted to help homeowners avoid foreclosure and stay in their homes—which would help preserve state and local property tax revenue. As the foreclosure crisis has worsened, states have continued to respond; you can learn about their most recent actions by looking at the latest updates to the Pew Center on the States’ April 2008 report, "Defaulting on the Dream."

Question
Will those steps be enough to close the budget gaps?

Answer
Unfortunately, no. States’ recent actions and special legislative sessions are aimed at fixing the immediate problems in the 2009 budgets. The Center on Budget and Policy Priorities reports that at least 28 states expect difficulty balancing their 2010 budgets, a number that has grown substantially over the last two months and may well climb higher as tax receipts continue to fall.

It’s clear, too, that solving those longer-range budget deficits will be tough. In many cases, the most obvious solutions—hiring freezes, travel cutbacks, marginal spending cuts—have been exhausted. Two primary solutions remain: tax increases and bigger budget cuts. The regular legislative sessions that begin in January will likely include much deeper cuts than we’ve seen so far. To balance their 2009 budgets, a number of states opted to cut higher education rather than K-12 educational spending. Next year may be dramatically different, though: even sharp reductions in elementary and secondary education are on the table, as in Washington, where Governor Christine Gregoire has indicated that she may recommend cuts of up to $1 billion in public school funding. Many priorities may be worth protecting from cuts, but in reality, no areas are immune.

The National Association of State Budget Officers and the National Governors Association reported in their most recent “Fiscal Survey of States” that 2009 will be the first time in 25 years that state spending will fall.

Question
With such difficult cuts to be made, how should legislators make those choices?

Answer
Policy makers have tough decisions ahead. But they also have a growing body of information and research that can help them make those choices. Like businesses, states increasingly are focused on return on investment—supporting policies and programs where the dollar goes further and delivers better results, leading to cost savings.

We’ve seen this in the area of corrections, where states including Texas, Kansas and Michigan expect to save tens of millions by finding solutions that both cut costs and protect public safety. Similarly, investing in high-quality early childhood education is a proven approach to delivering long-term cost savings.

As governors and legislators debate their next budgets, they should use solid data to guide their decision making. We recommend policy makers rely on two principles: 1) invest where the proven returns are the greatest; and 2) verify results to make sure taxpayers get what they pay for. Decisions based on these principles will stimulate growth, help the economy recover more quickly, and improve communication with the public, which wants and deserves explanations for the cutbacks ahead.

Question
What effect will the falling stock market have on states?

Answer
Stock market declines have hit states in their pension pocketbooks—hard. The value of California’s Public Employees’ Retirement System (CalPERS), the country’s largest public pension fund, fell 23 percent between July 1 and late October; similar drops have been reported in other states. State and local governments have increasingly invested their pension funds in equities—now as much as 70 percent, up from 38 percent in 1990—so even pension funds that were reasonably well funded a few months ago have faltered lately.

These drops won’t affect employees or retirees immediately. But if the market fails to recover within a year or two, states may require additional employee contributions or reduce retiree benefits to cover the losses. They’ll also need to be disciplined about making their own annual contributions in the face of other spending pressures. I’d encourage you to read more about the effects of the stock market on state pension funds through this article by Stateline.org, a project of the Pew Center on the States.  You also can learn about states’ public sector retirement systems through the 50-state report, “Promises with a Price.”

Question
How does this downturn compare with those of the past?

Answer
While it is too early to say definitively how this downturn will play out, the early data are not promising. The confluence of so many negative economic factors—home price declines, the falling stock market, rising unemployment—sets this period apart from other recent recessions. Data and projections from a number of groups, including the Nelson A. Rockefeller Institute of Government, the National Governors Association and the National Conference of State Legislatures, point to what may be a prolonged and particularly painful financial downturn for states.

Question
Will the Pew Center on the States assist states in addressing their financial issues?

Answer
Pew Center on the States’ research informs state discussions on economic issues, and we continue to explore topics for future reports that will add to the debate and help state leaders make some of the difficult decisions that lay ahead.  And through its State Management Lab, our Government Performance Project is working directly with states to help them improve their performance, including how they manage their money.

Question
How does the Pew Center on the States track these issues?

Answer
States’ fiscal health is a core theme of the work of the Pew Center on the States. Stateline.org reports on daily developments in state economies, Trends to Watch tracks long-term economic trends across all 50 states, and upcoming Center reports will further examine states’ fiscal conditions. Visit stateline.org and www.pewcenteronthestates.org for continued information about states’ responses to the fiscal crisis.

 
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