THE GOVERNMENT PERFORMANCE PROJECT
Financial Management50-State Average Grade: B
The recession of the late 1980s and early 1990s may have been the best thing that ever happened to state finances. It taught many of those in charge the obvious lesson that good times don’t go on forever. “We got burned in the mid-eighties and in the early nineties,” says Montana’s budget director, Dave Lewis. “We’re not going to be burned again.”
That is a consensus view in the Rockies, as well as on the East Coast, where even Massachusetts, long a subscriber to the drunken-sailor school of budgeting, has sobered up. In 1994, the state had a year-end deficit of $74 million, calculated on the basis of generally accepted accounting principles (GAAP). Then, its economy began to turn back up. In the old days, it would have spent all its surpluses on new, politically popular programs. Not anymore. At the end of fiscal 1997, Massachusetts had a $1 billion year-end balance.
Wisconsin, by contrast, sailed through the last recession without feeling much pain. Some in the state argue that it might have been better off in the long run if it had suffered a bit. Wisconsin has neglected to bring down its GAAP deficit, even though its economy has boomed and its unemployment rates are among the lowest in the country. The GAAP deficit was below $1 billion in fiscal year 1996, back up to $1.5 billion in 1997, and probably will be between $1 billion and $1.2 billion for fiscal year 1998. The legislature often uses its surpluses to allow for higher spending in the second year of the biennium—a practice that assumes continued growth.
Of course, there’s no question that it is a lot easier to manage a state’s finances in good times than in bad times. In a recession, states must choose between raising taxes, cutting budgets, or using smoke and mirrors to make it look like they are in structural balance.
When money is rolling in, on the other hand, states mainly have to avoid the lure of spending excess cash on new programs that will need to be supported in leaner years to come. Happily, with more than four out of five states running GAAP surpluses at the moment, the vast majority have avoided that temptation. Many have filled their rainy day funds to the statutory maximum, and a handful have even gone beyond the rule of thumb that says 5 percent of general fund revenues is a sufficient nest egg against hard times. Arizona and Indiana now have 7 percent in their contingency funds, and Maryland has 8 percent.
To be sure, a fair number of states still have a rough time estimating the growth in their Medicaid and corrections spending. But most are coming a lot closer than they used to. Even when the cost of these programs is rising fast, states seem increasingly willing to face up to the problem in the budgetary process, rather than wait and put in for supplemental appropriations in the middle of the year. Oregon, for example, saw its corrections expenses grow last year by a staggering 28.6 percent. But all the new jailhouses didn’t rock the budget; Oregon had estimated growth to be 2.8 percent more than it ultimately was.
Even some states with historically terrible reputations for financial management seem to be getting their houses in order. West Virginia is in solid structural balance and is actually paying its bills on time (not so long ago, vendors knew that the invoices they sent out in mid-winter wouldn’t be paid until the dogwoods were in bloom). Mississippi used to spend money like it was river water in the rainy season. But its Budget Reform Act, passed in 1992, requires that the state’s budget can’t exceed 98 percent of estimated revenues, plus the unencumbered general fund balance. Kentucky used to do no planning. Now, it plans for everything.
Don’t misunderstand. It’s not as though all the states have suddenly gotten religion. New Jersey, for example, continues to lowball its prison spending estimates every year. The resulting supplemental appropriations are jokingly referred to as the “midcourse corrections correction.”
And those bi-coastal sinners, New York and California—while somewhat improved—are still up to many of their old tricks. Neither can seem to finish its budget on time. New York’s debt keeps growing, albeit more slowly than it used to. By 2000, the $4.2 billion needed to service state debt will be larger than the projected capital spending budget. California, meanwhile, is dealing with its fiscal problems by seriously underfunding pensions and using short-term borrowing—even as it yields to the temptation of cutting motor vehicle registration fees.
Then there’s Connecticut. A quick look at its budgetary figures makes it appear that the state has really gotten its finances in hand. And to be fair, it deserves credit for paying off almost a billion dollars in notes and building its rainy day fund to 5 percent. But dig a bit deeper, and you find Connecticut uses a peculiar accounting practice that makes it look much better than it actually is. It recognizes expenditures only when they’re paid, but accrues revenues before they come in. Convert the state’s books to generally accepted accounting principles, and it turns out that its deficit has actually been growing—to $694 million in fiscal year 1998.
One positive trend, seen in a fair number of states, is a willingness to give agencies more flexibility in their financial affairs. Not so long ago, managers in most places were handed line-item appropriations and expressly forbidden to move money from one item to another, regardless of what circumstances might dictate.
But a growing number of governors and legislators now recognize that accountability is consistent with flexibility. Virginia allows its managers to move cash around freely between line items, with no approval from the budget office or anyone else. In fact, the state only maintains line items at all as a way to provide information for reviewing expenditure patterns.
In Utah, appropriations are generally made in one big lump. Program funding levels are identified, but agency heads can then shift money between them, as long as the actual spending figures are reported to the budget office and legislature. This can provide enormous latitude. For example, the new Department of Workforce Services, which encompasses unemployment, welfare, job training and child care, gets one single pot of transferable cash.
Even as agencies are being freed up to spend money in the way they think is most efficient, legislators are asking for—and getting—more information about the future cost of current programs. This is usually accomplished through a process in which fiscal impact statements (”fiscal notes,” as many states call them) are attached to the legislation in which the program is created. Legislators are free to ignore this information, of course. But it can have potent impact. Tennessee, for example, has required 10-year fiscal notes for its corrections spending since 1985. “That’s stopped a lot of legislation that would have increased the number of prisons or the length of terms,” says Jerry Adams, deputy commissioner of finance and administration. In 1997, North Carolina’s corrections expenditures grew by 10 percent and Arkansas’ grew almost 30 percent in the last biennium. Tennessee’s barely went up at all—in large part because the fiscal notes process works so well there.
In Delaware, the budget office reviews projections of future costs when state matching dollars are required in order to obtain federal funds. This is important for a state where the central state government provides many services that elsewhere are handled by cities or counties. “Monthly, we review applications for federal funds because of the ultimate impact on state funding,” says Chris Golden, executive assistant to Delaware’s budget director.
The ability of states to monitor and manage their spending can be helped dramatically by cost-accounting tools. This, however, is an emerging science. The difficulties inherent in figuring out all the indirect costs of an activity make it extremely difficult to break out the unit-by-unit expenses of any effort. It’s hard enough figuring the real total expense of handing out a new set of license plates. It may be impossible to come up with a good unit cost for something like avoiding a single teen pregnancy.
But when such data can be derived, it’s a terrific managerial tool. Utah, for example, has calculated that it costs $68 a day to house inmates in state facilities, compared with $42 a day in county facilities. Knowing that, the state is trying to keep its own capital development program down, while it does more contracting with the counties.
If all of this begins to seem rather matter-of-fact, perhaps a little history lesson is worthwhile. About 20 years ago, Maryland was the first state to convert to the first iteration of GAAP accounting. That was big news back then. Financial reporting in the states was a hodgepodge of methods, comparability between states was a distant dream, and only the bond rating agencies had much hope of comprehending state finances. Forget about cost accounting. Forget about fiscal notes. A state was progressive if it could report in a sensible way about whether it was in structural balance.
In the 1970s, New York didn’t even know it had a $2 billion deficit. “The books were so loose and kept in such an undisciplined manner,” recalled Ned Regan, who served as state controller, “that governors and legislators could not be held responsible for their actions.” This was before the state made a commitment to an early version of GAAP standards in 1980. Now the Empire State is a model of rock-solid accounting—even if its other financial practices remain questionable.
Or here’s another way to measure the same thing: Each year, the Government Finance Officers Association issues a Certificate of Achievement for Excellence in Financial Reporting. In 1980, one state got the award. In 1986, seven states did. In 1996, there were 36 of them.
That’s progress.
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