The Fiscal State of the States
By WILLIAM T. POUND ; January 14, 2002
DENVER -- Legislatures in 39 states will begin their regular sessions this month facing fiscal challenges unseen in at least a decade. Some of the problem is of their own making; during the cash- flush 1990's, America's state legislators passed tax cuts totaling $35 billion. Yet they were also responding to public demand for increased spending and are the victims of a slowing economy. Now, forced to find solutions, they may provide Congress with some ideas for reducing the federal deficit.
The last decade, especially the last seven years, was one of robust revenue growth for states. Legislators had significant latitude in budget decisions. On top of tax cuts, states boosted funding for schools, improved roads and bridges, extended health coverage to poor children and helped senior citizens with prescription drug expenses. And they put some money away for a rainy day. Now that rainy day has come — with a vengeance.
The effect of the recession on state finances is staggering. According to a December survey by the National Conference of State Legislatures, 43 states report revenues are below forecasts. Spending is already above budgeted levels in 19 states, and another seven expect cost overruns.
Practically no state has escaped unscathed in the current economic climate, and in some cases the budget holes are deep. California has an estimated $12 billion gap, larger than the general-fund budgets of 36 states. While smaller in dollar terms, the budget gaps in other states are no less painful.
Michigan cut spending and canceled capital projects. Ohio's plan to cover a $1.5 billion shortfall included spending cuts, tax increases and withdrawals from the tobacco settlement and rainy-day funds. Colorado canceled nearly $400 million in transportation and capital projects. Florida cut about $1 billion from its $20 billion budget and suspended a scheduled tax cut. Some state parks are closing in Tennessee. Nearly all state programs are vulnerable, even elementary and secondary education, which typically enjoys protection during a recession.
At the same time that state officials are dealing with a steep decline in revenue growth, they face a re-emerging challenge on the spending side of the ledger: Medicaid. The program is squeezing state budgets due to increases in prescription drug prices, demands by providers for higher payments and growth in the population eligible to participate in the programs. On average, Medicaid expenses rose 14 percent last year, more than double targeted estimates. This year's forecast is for 8.8 percent growth, and analysts are hoping they are on target.
Although the current economic decline began even before the events of Sept. 11, the terrorist attacks have exacerbated state budget problems. Tourism, which is crucial to many large states like New York, California and Florida, is down, and all states must also now address higher security costs.
Among state fiscal analysts there is a general consensus that economic conditions will not improve soon. That means state legislators have to close current-year budget gaps while enacting reduced budgets for next year. In legislatures that operate under term limits, many lawmakers are looking at budget reductions for the first time in their careers.
There is good news, though. State legislatures in the latter half of the 1990's wisely boosted reserve accounts, commonly referred to as rainy-day funds, to historic levels. As recently as 1995, those funds amounted to about $7 billion. By the end of 2001, the amount had more than tripled to $23 billion. Consequently, states are much better prepared to meet the current fiscal crisis than they were a decade ago. This is important because — unlike the federal government — nearly all states live under balanced-budget requirements.
Perhaps these rainy-day funds would be even more bountiful had states made more modest tax cuts. But tax cuts are often politically irresistible, never more so than when the budget is at a surplus, as was the case in many states in the late 1990's.
State legislators must face the consequences of the evaporating federal budget surplus, too. They have to be vigilant about maintaining federal commitments to Medicaid, welfare reform, highway and mass transit programs and children's health. And they are wary of new federal mandates for educational testing as well as new costs for security-related initiatives. Legislators must also deal with changes to the federal tax code, like last year's to the estate tax, that could deplete state coffers by billions of dollars.
During the last quarter century, most recently in the early 1990's, state legislatures have often had to wrestle with fiscal crises, and for the most part, they have adapted successfully. They are the places where America debates its most difficult public policy questions, and their solutions are often innovative. The challenges of the rainy-day economy are substantial, but they are not insurmountable.
William T. Pound is executive director of the National Conference of State Legislatures.
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