Study finds states struggling at recovery

By Jamey Dunn

A new study on struggling state budgets found that the recent recession exposed and exacerbated unsound practices occurring nationwide and left many states struggling to find stability.

The report released by the New York City-based State Budget Crisis Task Force focused on California, Illinois, New Jersey, New York, Texas and Virginia. According to the report, these states hold a third of the country’s population and account for almost 40 cents of every dollar spent by state and local governments. “The ability of the states to meet their obligations to public employees, to creditors and most critically to the education and well-being of their citizens is threatened,” Richard Ravitch, the former lieutenant governor of New York, and Paul Volcker, the former chairman of the Federal Reserve, wrote. Both are chairmen of the State Budget Crisis Task Force. “The conclusion of the task force is unambiguous. The existing trajectory of state spending, taxation and administrative practices cannot be sustained. The basic problem is not cyclical. It is structural. The time to act is now.”

States' spending has a significant effect on the economy as a whole. States spend a total $1.5 trillion annually. State and local governments cover 90 percent of education costs, and states spend an estimated $200 billion annually on health care for the poor each year. States are also important employers. They employ more than 19 million workers, which account for 15 percent of all workers in the nation. States employ six times as many people as the federal government.

But employee headcounts are shrinking as states face post-recession budget realities. According to the report, states are facing budget shortfalls that total an estimated $55 billion. States responded to the crisis by dipping into reserves, if available, raising taxes and cutting, especially staff. According to the report, Illinois lost 23,300 state and local government jobs from June 2009 to May 2012. New York saw comparable numbers. But most states in the study experienced more public jobs cuts than Illinois and New York. California saw state and local employment dip by 125,800 over the same period. Only New Jersey lost less than Illinois, at 21,600. The report said that states targeted personnel costs for larger cuts after the 2008 financial crisis more than they did in other recent economic downturns. “This is a fundamental shift in the way governments have responded to recessions and appears to signal a willingness to “unbuild” state government in a way that has not been done before,” the report said.

The report found that state budgets fared worse in the downturn than other areas of the economy and would likely take longer to bounce back. “The sharp deterioration in state finances as a result of the 2008 financial collapse and associated recession is well-known. State government tax revenues were hit much harder than the overall economy. Although real gross domestic product declined by 5.1 percent during the recession, the components of personal income typically taxed by state governments declined by 10 percent; and consumption of items typically subject to state sales taxes declined by 11 percent.”

As Congress seeks to reduce the federal deficit in wake of the recession, the authors of the study also try to predict the potential impact of cuts to federal funding, which they say would most likely hit grants that go to states. “Even if Congress and the president do not cut the federal budget drastically this year or next, significant cuts are almost certain over the longer term. We may assume that areas such as defense, Social Security, Medicare, and net interest will not be cut as deeply as other programs. If this is the case, federal grants to state and local governments will be a primary target of federal budget cuts.” The study says a 10 percent cut to such grants would mean a $60 billion reduction in funds going to states. The study says such a cut would be “equivalent to more than doubling the corporate income tax, cutting police and fire spending almost in half, or eliminating all spending on libraries, parks and recreation.” Under such a reduction, Illinois would lose $2.3 billion.

However, the study said that not all state budget problems can be blamed on the recession. Growing health care and retirement costs, coupled with budget gimmickry, had set many states, including Illinois, up for a fall. “The rapid growth in Medicaid spending has pushed aside other types of state spending. Medicaid recently surpassed K-12 education as the largest area of state spending when all funds, including federal funds, are considered; Medicaid appears likely to continue to claim a growing share of state resources,” the report said. All six states in the study have made efforts to slash Medicaid liabilities. Illinois is not the only state that has pushed off Medicaid bills from one fiscal year into the next. Texas intentionally underfunded its Medicaid program and now must make up a $4.8 billion shortfall by September 2013.

It will come as no surprise to Illinois residents that pension and retiree health care costs are also included in the reports analysis of budget challenges. According to the study, California, Illinois and New Jersey account for more than half of the total unfunded liability for pension costs nationwide.

All six states were guilty of using budget gimmicks or paying for ongoing costs with one-time-only revenues. California, New Jersey and New York joined Illinois in borrowing against tobacco settlement revenues, a budgeting trick called securitization. All six states have delayed payments to local governments, schools or vendors. All six have also used fund sweeps to balance their budgets. All the states but Texas have borrowed either to refinance other debt or cover annual costs, including pension payments.

The report makes a number of recommendations, including that states make budgets more transparent and create multi-year projections that are more than just window dressing. The study also suggests that states make their pension funds more transparent by reporting on investment risks. The authors say that states should create automatic funding mechanisms to ensure that pension payments are made, as well as automatically deferring some money each year into rainy day funds.