For Many State Budgets, a Year of Relief

Few state economies — or state budgets — were hit as hard by the recession as those of Arizona, Michigan and Rhode Island. Three years ago, desperate for an infusion of immediate cash, Arizona decided to sell parts of its state Capitol complex to private investors. Two years ago, Michigan had endured a full decade of budget crises — the state lost jobs every year between 2000 and 2010 — but was still cutting its higher education budget. Last year, Rhode Island was forced to take control of bankrupt Central Falls, even as the state closed its own $300 million budget gap with a mix of service cuts and tax increases.

This year, all three states could claim budget surpluses.

These weren’t the only states whose fiscal fortunes were changing for the better. Budgets in a majority of states started to show a substantial recovery. That progress changed the choices states were considering.

Unlike a year ago, fewer states were debating tax increases and spending cuts. Instead, more were weighing the relative benefits of restoring services that were cut, rebuilding their reserves or cutting taxes, and several did approve substantial tax cuts. Those more palatable options also contributed to a year of relative budget peace, with fewer states seemingly in danger of not completing their budgets before the start of the new fiscal year.

Yet the peace wasn’t universal. A few states, most notably Illinois and California, have confronted budget crises reminiscent of the ones many states faced in the depths of the recession. Others had to cope with budget gaps that may have looked small compared to previous years , but still forced difficult decisions. And, even in the states enjoying short-term prosperity, lawmakers weighed how to prepare for longer-term threats — the uncertain global economy, the prospect of federal budget cuts and growing health care costs — that they know are on the horizon.

Climbing Back

Last year at this time, the budget drama was just getting started in Minnesota, which was headed toward a disruptive three-week government shutdown, and in Connecticut, where the budget was thrown into chaos in late June when unions voted against making concessions. This year things are different.

While some states haven’t completed their budget work yet, including California, New Jersey and Pennsylvania, there’s no obvious Minnesota or Connecticut in the bunch. Maryland, Virginia and Washington all faced budget stalemates, but ultimately finished their work long before the start of the 2013 fiscal year, which for most states begins July 1. Others reached agreements with relative ease.

That’s partially just a fluke of states’ budget calendars. It happens that many of the states that had the hardest time finishing their budgets last year, including Connecticut, Iowa, Minnesota, Nevada and Texas, are biennial budget states. This year, they only had the much-easier task of updating the two-year budget approved last year or didn’t have to do anything at all.

But it also reflects the real improvement in the states’ fiscal condition: It’s a lot easier to write a budget in good —or somewhat better — times than bad. The Nelson A. Rockefeller Institute reports that state tax revenue has grown for nine consecutive quarters. The National Conference of State Legislatures found this spring that only nine states had new gaps emerge in their Fiscal Year 2012 budgets, while 29 expected to have at least some money left over at the end of the year.

This progress deserves several caveats. NCSL reports that states will end up having closed $32.2 billion in budget gaps for Fiscal Year 2013, while the Center on Budget and Policy Priorities puts the number at $54.4 billion. Those numbers are down compared from what states faced earlier in the recession, but are still substantial. When adjusted for inflation, state revenue hasn’t returned to peak levels in most states yet.

“States,” says Don Boyd, executive director of the Taskforce on the State Budget Crisis, “are looking up from the bottom of a cliff.”

Cutting Taxes

Still, lawmakers were eager to leverage whatever progress they could find. These improving conditions, combined with the power anti-tax Republicans won in the 2010 elections, led more states to consider tax cuts. The biggest, broadest tax cuts were in Kansas, where Governor Sam Brownback signed into law a plan that will cut personal income taxes and business taxes and allow a previous sales tax increase to expire as planned.

Republicans in Maine also enacted legislation that is likely to eventually cut personal income taxes deeply. Under the law, in future years 20 percent of any revenue the state brings in beyond what it budgeted for will be used for permanent tax reductions, until the tax is cut from its current top rate of 8.5 percent all the way down to 4 percent. “It puts tax relief and economic development on par with government spending,” says Jon Courtney, Maine’s Senate Majority Leader.

Elsewhere, Idaho and Nebraska approved smaller personal income cuts. Arizona signed off on a substantial reduction on taxes on capital gains. Both Indiana and Tennessee voted to end their estate taxes over time. Georgia approved a large tax overhaul that constitutes a net tax cut. Like Maine and Kansas, every one of these states has a Republican governor and a Republican-controlled legislature.

Meanwhile, broad-based tax increases were rare. New York partially extended temporary income tax increases late last year, while Democrat-dominated Maryland raised income taxes on people who earn $100,000 a year and up.  On taxes, the big unanswered question is California. Democratic Governor Jerry Brown’s plan for closing a $15.7 billion budget gap depends on voters choosing to raise both income and sales taxes at the polls in November.

Save or Spend

Even in states where Republicans are in control, though, tax cuts were not universal. Instead, lawmakers who had some extra money to work with had a choice. They could provide immediate help to their citizens by restoring services they cut previously and by cutting taxes. Alternatively, with an eye to the future, they could rebuild reserves and pay down long-term liabilities such as pension obligations.

Many states made at least some effort to restore budget cuts, but often only in part. In Florida, for example, Governor Rick Scott championed an extra $1 billion for schools, but the move came a year after lawmakers had cut $1.3 billion from education.

In many states, with the recession fresh in their memory, lawmakers were reluctant to cut taxes too much or restore spending too quickly out of fear that they couldn’t afford ongoing commitments. That was especially true in Michigan, where the state never really recovered from the recession in the early 2000s before the Great Recession hit. ”The 2000s were pretty much a decade of austerity,” says Craig Thiel, director of state affairs for the Citizens Research Council of Michigan.

So, the state is working to rebuild its cushion for the next recession, putting its rainy day fund on a course to have $500 million at the end of the 2013 fiscal year — the most the fund has held in more than a decade. Democrats tried to direct more money to schools, but were rebuffed by Republicans in the legislature. Likewise, in Arizona, in addition to cutting taxes, lawmakers committed $450 million to the state’s rainy day fund.

New Gaps

Meanwhile, other legislatures still were burdened with the unpleasant choices of the last few years. Those states, California and Illinois most prominent among them, have problems that run much deeper than the economy’s recent troubles.

In California, as lawmakers have weighed their options, the state’s fiscal condition has continued to deteriorate. Governor Brown announced last month that the state’s budget gap had grown to $15.7 billion in May from $9.2 billion in January, after revenue forecasts proved overly optimistic. With Republicans able to block any legislatively enacted tax increases thanks to the state’s supermajority requirement, the most likely outcome for the budget is a new round of cuts with even deeper ones if voters don’t approve Brown’s tax increases at the ballot.

In Illinois, lawmakers raised cigarette taxes by a dollar a pack and directed the money to Medicaid, then also made deep cuts to payments for Medicaid providers. “The $2.7 billion changes in the program is the largest restructuring in the history of the state’s Medicaid program,” says Laurence Msall, president of the Chicago-based Civic Federation. Yet Msall points out that while those changes will put a dent in the state’s unpaid Medicaid bills, Illinois will still have a backlog of bills that totals more than $8 billion.

Despite proposals from Governor Pat Quinn and counterproposals from legislators, the state also didn’t act to address the $83 billion unfunded liability in its pension system. Lawmakers may return for a special session on the topic.

Illinois and California’s long-term problems are well-documented, but lingering budget headaches were shared by other states, as well.

Anticipating substantial shortfalls in both its fiscal year 2012 and 2013 budgets, Louisiana tapped its rainy day fund and one-time sources of money, much to the dismay of some conservatives in the legislature who preferred deeper cuts. Alabama is counting on voters in September agreeing to transfer $145 million from a fund with oil and gas revenue to the state’s general fund or else the state’s budget will fall out of balance. That’s after lawmakers already slashed the general fund by more than 4 percent compared to a year earlier, reducing funding for corrections and social services.

In Connecticut, lawmakers were forced to close a $200 million budget gap that had emerged in the second year of their two-year budget. That was still a relief compared to a year earlier, though, when Governor Dan Malloy secured large, controversial tax increases and hard-won union concessions in the face of a shortfall of more than $3 billion. “I think there’s a lot more room for optimism today than there was a year-and-a-half ago when we started,” says Ben Barnes, secretary of the Connecticut Office of Policy and Management.

Still, Barnes favors caution. “We have no business making serious program expansions or tax cuts,” he says, “or at least the bar for agreeing to something like that is extremely high.”

Danger Ahead

Even in the states where the recovery is looking stronger, there are real doubts about whether it can last. That’s partially because of risks that are shared by all states, from the economic turmoil in Europe to the prospect of cuts in federal aid as Congress moves to implement or modify the debt-reduction deal reached last summer.

It’s also because each state faces its own unique dangers. Michigan remains heavily dependent on the auto industry, which has made a rapid recovery, but faces uncertain prospects for the future. In Arizona, a sales tax increase enacted in 2010 is set to expire May 31, 2013, which would put more pressure on the state’s budget.

In Rhode Island, lawmakers are working with a $100 million surplus as they put the finishing touches on next year’s budget. Nonetheless, Rhode Island’s unemployment rate remains stubbornly high at 11.2 percent — and has gone up for three straight months.

That’s one reason Ashley Denault, director of research at the Rhode Island Public Expenditure Council, worries about what’s ahead. “The state has had to work very hard and dig pretty deep to balance budgets and having one year of good news is encouraging,” Denault says. “But we would rather see a more thoughtful plan for the future.”