Do States Really Balance Their Budgets?

Loopholes, unexpected expenses and glorified revenue predictions make balanced budgets an unattainable reality for some legislatures.

In recent months, there’s been a great deal of talk about whether or not the federal government should be required to pass a balanced budget each year. We don’t know enough about the machinations of the federal budget to comment on this. But we do know that, over the years, we’ve wondered about state leaders who tell us that they somehow achieve fiscal prudence thanks to their own balanced budget laws. Forty-nine states have a mandate of this kind; Vermont is the only exception.

Our own somewhat jaundiced view of what constitutes a balanced budget emanates in large part from headlines about state fiscal woes that have been on the front pages of newspapers for the last three years. It seems to us that, for some states, a balanced budget is a benign state of affairs that exists for a few days or weeks. Then, revenues start coming in below predictions or expenses climb unexpectedly, and the balanced budget is little more than a fragment of past hopes.

“They compare the expenditures they can expect to the cash they expect to take in,” is the way Byron Schlomach, director of the Center for Economic Prosperity at the Goldwater Institute, explains it. “There are uncertainties in both of those, and the estimates can be adjusted to be realistic or unrealistic.”

Some balanced budget requirements are statutory and some are constitutional. In either case, there’s wide variation in their strictness.

Consider Illinois. According to John Tillman, CEO of the Illinois Policy Institute, the provision in the constitution, which was drafted in 1970, was written purposely with loopholes so that the state could call it a balanced budget requirement without actually balancing the budget. “These loopholes,” Tillman says, “have allowed the state to end recent fiscal years deeply in the hole, while still claiming at year’s beginning that all is in balance.”

Medicaid is one example of how budgetary monkey business can present an illusion of balance. It’s easy to understate Medicaid costs at year’s beginning -- all budgeters need to do is pick a caseload estimate that fits neatly with the money available. The understatement of costs doesn’t wind up leaving beneficiaries short, because there is the assurance that the money will be found someplace through the year. Medicaid, after all, is an entitlement.

In Texas, for instance, state Medicaid dollars for the coming biennium were underfunded by at least $4.8 billion, according to the Center on Budget and Policy Priorities. More than $2 billion of that was an artifact of federal stimulus dollars that are no longer available to the state. Texas is not alone in such budgetary sleights of hand. At some point during the year, the states that have balanced their budgets in this way are going to have to find some other source of cash -- or some combination of cuts -- to pay their Medicaid bills.

In Arizona, when the balanced budget begins to fall apart, the state tends on occasion to borrow money. You wouldn’t think that would be possible, since it has a constitutional $350,000 debt limit. But according to Schlomach, although the state has technically accrued billions in debt, the courts “have simply defined debt as not being debt.”

One state that has largely eschewed these kinds of gimmicks is Vermont -- the one that has no balanced budget mandates and yet typically has a balanced budget. Some of the explanation for this is that even though Vermont has very generous social welfare benefits, its population is comparatively less dependent on them than in many other states. So it often avoids the unexpected crushing bills that hit states like California.

Beyond that, according to James Reardon, commissioner of the Vermont Department of Finance and Management, the state doesn’t really apply the flexibility “that the lack of a balanced budget requirement theoretically allows.” There’s something in the fresh Vermont air that seems to produce an ethos of fiscal rectitude which seems far more potent than codified regulations. Even during the difficult fiscal times of the last few years, both the governor and Legislature were able to avoid using its rainy day fund money (though it did use human services reserve fund money).

We’re hardly the first to note that balanced budgets in the states aren’t as effective as people might claim. But some studious observers have even suggested that they can potentially be counterproductive.

Consider this: Might states be better off with broader constraints on the amount they’re allowed to overspend in bad years as long as they’re required to pay down those bills in good years? This may sound like a recipe for more budgetary monkey business, but given the ease with which many states can circumvent their balanced budget requirements, it feels like the benefit of such an approach comes in transparency and honesty about what’s really happening in the budget.

“My own view is that you’d be much better off with an ability to balance your budget over a three- to five-year cycle,” says economics professor Mark Thoma of the University of Oregon. His point is that the balanced budget rules have codified a great deal of volatility at the state level. They have done so as a way to make up for the perceived inability of state legislatures to make the kind of sensible decisions necessary to keep a state’s fiscal ship afloat even in rocky seas.

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