Fiscal Balance

States Had Fewer Annual Deficits a Year After the Pandemic-Induced Recession

Only five states recorded annual deficits in fiscal year 2021, a sharp decline from the prior year when the COVID-19 pandemic threw the finances of 19 states out of balance. Swift and unprecedented federal aid to states and skyrocketing tax collections contributed to the sharp turnaround. Still, long-running shortfalls that started years before the pandemic in several states may result in an unsustainable fiscal situation if left unmanaged.

Although most states balance their budgets on an annual or biennial basis, budgets alone offer an incomplete picture of whether revenue—composed primarily of tax dollars and federal funds—matches spending across all state activities. Looking beyond budgets to states’ financial reports provides a more comprehensive view of how public dollars are managed.

At the beginning of the pandemic, the federal government acted quickly to deliver robust financial support to states facing a slump in tax collections and a spike in spending demands. But despite the additional federal funds, 19 states closed fiscal 2020 with an annual deficit—the most states since the Great Recession.

The tides turned for states the following year, as tax revenue in almost half of states not only recovered from the historic plunge but outperformed pre-pandemic trends. Only Hawaii, where revenue covered just 91.6% of expenses, Illinois (96.2%), Connecticut (96.5%), New York (98.3%), and Massachusetts (99.1%) had deficits in fiscal 2021, while many states accumulated notable surpluses. Alaska, for example, collected enough revenue to cover more than 230% of its annual expenses, a remarkable bounce back from the prior year when the state had the largest annual deficit of any state. Alaska’s tax revenue sources are historically quite volatile, and investment earnings largely drove the growth in fiscal 2021.

But the revenue wave and accompanying federal aid were not enough to bring most states with long-term deficits into fiscal balance. Eight states still recorded a 15-year shortfall at the end of fiscal 2021. Kentucky (100%) was the only exception. Three years of annual surpluses—after about a decade of deficits—allowed the state to finally bridge its long-term gap between revenues and expenses. Meanwhile, New Jersey and Illinois accumulated the largest 15-year deficits, taking in enough total revenue to cover just 92.5% and 93.8% of expenses, respectively.

States can withstand periodic deficits without endangering their fiscal health over the long run, but chronic shortfalls are one indication of a more entrenched structural deficit in which, without policy action to correct the imbalance, revenue will continue to fall short of spending.

Zooming out from a narrow focus on annual or biennial budgets offers a longer-term lens that can help policymakers budget with an eye toward the future. The annual or biennial cycle can mask deficits because they allow shifts in the timing of when states receive cash or pay off bills to reach a balance. For example, states can accelerate certain tax collections or postpone making some payments to balance the books. Clarity on the long-term picture can help states better align spending and revenue before gaps between needs and available resources become larger and more painful to close.

State highlights

This indicator assesses states’ performance from two perspectives: first, by comparing a 15-year lump sum of revenue relative to expenses to uncover states’ ability to bring in sufficient funds to cover costs over the long term; and second, by examining year-by-year financial records for each state to identify how often they experienced shortfalls.

Comparing states’ total revenue from all sources and expenses (adjusted for inflation), in aggregate and year-by-year from fiscal 2007 to 2021, shows that:

• In addition to New Jersey and Illinois, states with symptoms of structural deficits were Connecticut (95.2%), Hawaii (95.6%), Massachusetts (96.4%), Maryland (98.8%), New York (99%), and Delaware (99.6%). All but Delaware experienced deficits in at least 10 of the 15 years studied.
• Illinois is the only state to run a deficit in each of the 15 years. New Jersey previously shared this record, but the state reached an annual surplus of 104% in fiscal 2021, breaking its deficit streak.
• Alaska accumulated the largest 15-year surplus (136.1%), followed by North Dakota (124.9%), Wyoming (122.2%), Utah (110.7%), and Montana (108.5%). Resource-rich states tend to acquire large surpluses in boom years that can help cushion shortfalls when oil or mining revenue decline.
• Aside from Montana, which was the only state to end each year with a surplus, 10 states recorded just one deficit over the 15 years examined: Idaho, Iowa, North Carolina, North Dakota, South Carolina, South Dakota, Tennessee, Texas, Utah, and Virginia.
• The 50-state median revenue was 103% of expenses over the 15 years. Additionally, each census region accumulated a long-term surplus, with the median for the West leading at 104.4%, followed by the South (103.6%), Midwest (103.2%), and Northeast (100.7%).

Year-by-year trends

Changes in the economy can move a state’s annual revenue and expenses out of balance, as can policy decisions such as tax or spending changes.

Looking at states’ balances year by year, shortfalls were most widespread during and immediately after the 2007-09 recession, when in fiscal 2009 a record 46 states failed to amass enough revenue to cover their annual expenses. Another wave of annual deficits occurred in fiscal 2016 and 2017, as many states slogged through the weakest two years of tax revenue growth outside of a recession in at least 30 years. Except for the pandemic year of fiscal 2020, most states have reported regular annual surpluses since fiscal 2017, driven in part by widespread tax revenue gains.

New accounting rules that became effective in fiscal 2018 may have also played a role. These rules changed how states estimate unfunded retiree health care costs, lowering expenses in some states, at least on paper. As a result, fiscal conditions pre- and post-2018 are not directly comparable.

Although official accounting reports for fiscal 2022 are still pending for some states, recent data shows that revenue collections continued to soar, but spending also climbed. Further, states that have published their financial reports for that year have largely recorded surpluses, including some that historically have struggled closing the gap between revenue and expenses. But balancing the books in the short term may not be enough to shift the status quo for states with 15-year deficits. Those states may need several years of balanced revenue and expenses to close their long-term gaps.  

Why Pew assesses fiscal balance  

By taking a step back and considering how 15-year total revenue aligns with expenses, The Pew Charitable Trusts aims to help states evaluate whether they take in enough money to cover their expenses or need to change course to bring their finances onto a sustainable path. Rather than track cash as it is received and paid out, as budgets generally do, annual comprehensive financial reports attribute revenue to the year it is earned, regardless of when it is received, and assign expenses to the year they are incurred, no matter when the bills are actually paid. This approach captures deficits that can be papered over in the state budget process.

Accounting for funds in this way is like a family reconciling whether it earned enough income over 12 months not just to cover costs paid with cash but also to pay off credit card bills and stay current on car or home loan payments, rather than pushing some charges off to the future.

Importantly, however, just because a state raised enough revenue over time to cover total expenses does not necessarily mean that it paid every bill. When a state’s annual income surpasses expenses, the surplus is sometimes directed toward nonrecurring purposes, such as paying down long-term obligations such as unfunded pension or retiree health benefits or bolstering reserves. But in other cases, a state might use regular surpluses to create or expand services and to pay the associated recurring bills, while falling behind on annual contributions to its pension system or other existing bills.

So, although reviewing financial reports, rather than simply looking at annual or biennial budgets, captures states’ capacity to pay their bills, it does not reconcile whether revenue was used to cover specific expenses.  Further insights can be gleaned from examining states’ debt and long-term obligations.

For instance, a state whose annual revenue falls short of expenses generally still balances its annual budget, turning to a mix of reserves, debt, and deferred payments on its obligations to get by. But states that are forced to rely on these strategies regularly risk a vicious cycle in which deficits lead to short-term fixes that exacerbate the deficits and harm residents and businesses. For example, because of chronic deficits, Illinois lawmakers regularly delayed payment to hundreds of vendors, including scores of small businesses and nonprofit organizations, for more than a decade. But this just made the problem bigger—the backlog peaked at $17 billion in 2017—because Illinois pays up to 12% annual interest on unpaid bills. (The state has made progress getting the problem under control.)

To avoid outcomes such as Illinois’, states should seek to prevent structural deficits before they start. Pew recommends that states do this by using an analytical tool called a “long-term budget assessment”—which uses projections of revenue and spending at least three years into the future to evaluate whether the state is likely to experience deficits and, if so, why. For example, by conducting a long-term budget assessment, New Mexico discovered that starting in about 15 years it would face regular and growing deficits, driven mainly by expected declines in oil and gas production. In response, lawmakers used the state’s temporary surplus in fiscal 2023 to add hundreds of millions of dollars to various endowments and trust funds, which it anticipates will generate sufficient investment earnings to increase revenue in perpetuity and reduce the deficits.

Because they take a forward-looking approach to structural balance, long-term budget assessments are a logical supplement to Pew’s state fiscal balance indicator.

Joanna Biernacka-Lievestro is a manager and Page Forrest is a senior associate with The Pew Charitable Trusts’ Fiscal 50 project.

Notes