Why the State Budget Crisis is Real

According to two new reports, states’ fiscal situation is either (a) looking better or (b) looking worse. Pay attention to (b).
by | August 13, 2012

What's going on with state budgets? The latest survey of state fiscal officers put out by the National Conference of State Legislatures concludes that the states' economic outlook has stabilized as revenues slowly rebound. Forty-four states reported year-over-year revenue growth, with 19 of them reporting growth of 5 percent or more. Even though state budgets are seen as remaining vulnerable to job losses, developments in Europe and other economic shocks, the overall picture drawn by the NCLSL report seems pretty reassuring. Not "happy days are here again," but nothing to lose sleep over.

But hold on. Didn't the State Budget Crisis Task Force just issue a report with a much more alarming message? Indeed. The magnitude of the problem, that report's authors write, "extends beyond the impact of the financial crisis and the lingering recession. 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."

So which is it, no biggie or major crisis? And does it matter much? I'll answer the second question first. Yes, it matters a great deal. State governments are responsible for providing most domestic governmental functions such as public education, health and welfare services, and public safety and corrections. States and localities finance three-quarters of our infrastructure, employ 19 million workers and spent a combined $2.5 trillion in 2009, which is more than the federal government spent on the direct implementation of domestic policy.

Is there a crisis? The task force report makes a convincing case that the problems states face are structural, not cyclical, and that states' current policy and governance trajectory is unsustainable. Financial problems of a cyclical nature will improve as the economy recovers, but structural problems will persist irrespective of the business cycle. That's a crisis. Serious policy changes are needed.

The task force cites six major threats to fiscal sustainability, each of which is enough to sink a state financially: Medicaid is the single largest state expenditure and is growing faster than both the economy and state tax revenues; federal aid is the largest source of state revenue and will surely be cut deeply given the financial situation in Washington; state pension systems are underfunded to the tune of at least $1 trillion, even holding aside state obligations for health-care benefits for retirees; the states' tax bases have been eroding for decades and are increasingly volatile; the increasing fiscal distress of many local governments will negatively impact the states; and finally, the budget practices of states — "kicking the can down the road" — hinder fiscal stability and mask imbalances.

The task force's conclusions are consistent with those of a report issued by the U.S. Government Accountability Office earlier this year indicating that, absent policy changes, the fiscal position of the state and local sector would decline steadily through 2060. Closing the revenue-expenditure gap, GAO said, would "require action to be taken today and maintained each year equivalent to a 12.7 percent reduction in state and local government current expenditures."

I'm not the first to notice these contrasting views of state budgets. A recent Huffington Post piece took note of it, and the reporter pushed the point with Richard Ravitch, co-chair of the State Budget Crisis Task Force. I have to agree with Ravitch's response: "It is getting worse every day. We have to stop bulls---ting."

Mark Funkhouser  |  Director, GOVERNING Institute
mfunkhouser@governing.com

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