Finance

Mischief After Midnight

Last summer, just as the nation's credit markets were about to tighten, Gregory Schmidt received a loan from his bank under extraordinarily generous terms. His...
by | May 31, 2009

Last summer, just as the nation's credit markets were about to tighten, Gregory Schmidt received a loan from his bank under extraordinarily generous terms. His interest rate: zero percent.

Schmidt, the secretary of the California Senate, didn't get this deal because of his impeccable credit score. Instead, he and hundreds of other legislative staffers in Sacramento received the deal because the state budget was late.

In California, when lawmakers fail to approve a budget by the start of the fiscal year, legislative staff don't get paid until the deadlock is broken. Blown budget deadlines are so frequent in California--the state has missed its June 15 constitutional deadline 28 times since 1977--that Sacramento banks have gotten into the habit of giving out no-interest loans to their state-employed customers whose pay has been frozen. "Everyone does it," Schmidt says.

This arrangement reflects just how notorious California legislators are for failing to do their job on time. But California isn't the only state that has this problem. As the 2009 calendar turns toward July 1, it's a safe bet that quite a few legislatures will be in a mad all-hours dash to finish the budget before the new fiscal year starts. Almost certainly, some won't make it, leading the media to condemn lawmakers for abdicating their constitutional obligations.

At this time of year, in much of the country, state legislators bear a certain resemblance to college students. After months of procrastinating, they try to cram their most important work into a few short days. All-nighters are common. It's not a pretty sight. And in a year of fiscal shortfall, the number of ugly situations is likely to be greater than usual.

But are late budgets really such a big deal? Well, no and yes. Sometimes, even without a budget, states go about business as usual. In other cases, government really does grind to a halt. It all depends on just how late the budget is, what the state's rules are and what the politicians in charge decide to do.

If there's one common thread, it's this: The pain from a late budget can extend far beyond the agencies of state government. If the stalemate lasts more than a short time, schools have trouble figuring out how many teachers they can hire. Local governments aren't sure what their property tax rates should be. Vendors and nonprofits don't know whether their funding stream will be cut off. Everyone who depends on state government is left in a condition of uncertainty.

So it's not surprising that efforts have been made in many places to prod legislators to do their work on time. The most common effort has been to make the personal consequences of a late budget so severe that lawmakers won't dare finish late. But it's an approach that hasn't had a lot of success. What seems to make more sense is for the interested parties to find ways to adapt to late budgets--as the banks in Sacramento have done for Gregory Schmidt and his colleagues.

Not all states make a habit of behaving this way. Some have, throughout modern history, always approved a new budget prior to the start of the next fiscal year. When a dispute over transportation spending stymied Virginia's lawmakers in 2006, elected officials debated whether government would shut down if there were no budget by July. No one knew for sure because it had never happened under the existing constitution. The budget had nearly always been wrapped up in early spring. Ultimately, the budget passed in June and the question didn't have to be answered.

As a rule, it's the big states, which tend to use annual rather than biennial budgets, that have the worst problems. At the top of that list are California, Massachusetts, New York and Pennsylvania. In New York, where the early April 1 start to the state fiscal year presents special challenges to lawmakers, it was big news in 2005 when the budget passed on schedule for the first time in 21 years.

Budgets are late due to a combination of politics and procrastination. While governors tend to introduce their budgets in January, the hard work often doesn't begin then. Legislators like to wait for data from April 15 tax collections to have a more concrete idea of how much money will be available to them. They wait for revisions they know are coming from the governor. They wait and they wait and they wait.

One reason they do it is that they realize this form of procrastination doesn't usually lead to chaos. What's more likely to cause chaos is political posturing. Since Pennsylvania Governor Ed Rendell took office in 2003, the state has never finished its budget work on time. This mostly has been the result of bickering between the governor, a Democrat, and Republicans in the legislature. In 2003, some spending bills weren't signed until December, six months after the June 30 deadline. But only once, in July 2007, did a brief government shutdown occur because leaders in the House wouldn't allow a stopgap budget to reach the floor.

In some states, shutdowns basically can't happen, either because courts have given the governor power to fund government in the absence of budgetary authority, or because legislators can pass stopgap budgets when they're unable to complete their work on time. Still other states have short legislative sessions that are required to end long before the new fiscal year begins, meaning the budget is almost guaranteed to be finished before a shutdown can occur.

But none of those safeguards are much help to California. It pays a significant price for long budget delays, even when state government appears to be functioning more or less normally. In 2003, the state paid $140 million just for not finishing on time. Without a budget in place, credit markets wouldn't accept the type of bonds the state normally floats for short-term borrowing. California was forced to turn to other bonds with higher interest rates--the state, unlike the legislative staff, doesn't get interest-free loans from Sacramento banks. The longer the budget delay, the greater the threat to overall state credit ratings, with the prospect of higher borrowing costs for years to come.

Beyond those easily quantifiable costs, California demonstrates the widespread effects that late budgets can have even without any government shutdown. Last year, lawmakers in Sacramento stalemated as they tried to close a massive budget shortfall. Democrats wanted tax increases; Republicans wanted huge spending cuts; and neither side would budge. A two-thirds requirement for passage only made the problem worse. Ultimately, the budget wasn't signed until September 24, making it the tardiest in state history.

During the nearly three months when the state lacked a budget, workers at state agencies (unlike legislative aides) did receive paychecks. Courts have ruled that federal labor law protects the salary rights of civil service employees. But without a budget, the state was forced to withhold several billion dollars in payments to school districts, community colleges, nonprofits, Medicaid providers and vendors of various services and products.

These missed payments came with real consequences. Community colleges had to scrounge up money wherever they could find it to pay for day-to-day operations. Some temporarily transferred money from other accounts, such as employee retirement funds. Some borrowed money from counties. And some issued short-term bonds. Each of these steps came with adverse side effects, whether they were lost earnings on retirement fund investments, or fees and interest payments associated with borrowing. The situation was even worse for nonprofits and vendors that were depending on the cash the state owed them. Several child care centers were forced to close their doors temporarily.

The 2008 California case is an extreme one. Budget delays in most states, if they are brief, don't seriously imperil school systems or social services. Still, late budgets can have consequences that legislators rarely bother to think about. Local governments, unsure how much money they will receive from state sources, find their own budgeting processes disrupted. Long-term planning becomes much more difficult. "A well-managed state," says Scott Pattison, executive director of the National Association of State Budget Officers, "would never, ever do this."

What's less clear is how the states that face this chronic problem should try to deal with it. Is there a way to force lawmakers to act more promptly?

It's not impossible to punish legislators individually for missing budget deadlines. This year, in his State of the State address, California Governor Arnold Schwarzenegger proposed that all legislators and state constitutional officers should forfeit their pay during any period when the budget is past due--and not get it back retroactively when the crisis is resolved.

Matt Dean, a Minnesota state representative, came up with a similar idea after his state's brief government shutdown in 2005. Dean felt party leaders and committee chairs in the legislature didn't feel enough urgency to negotiate a deal. They'd feel the heat, he suggests, if they knew that their legislative colleagues--the people who put them in positions of leadership--were about to lose their pay.

But there are political obstacles to this sort of gambit. When Dean tried to sell his idea to the Minnesota House, he didn't get far. "It was met with bipartisan disapproval," he says. "I kind of got beat up by my own caucus for putting it forward." Even if Dean had gotten his way, there's no guarantee it would have solved the problem. Since 1998, New York legislators have had their pay suspended whenever the budget is late. They haven't stopped missing the deadline.

In the end, the strongest protection against marathon budget stalemates is the public reaction to any kind of government shutdown. When lawmakers know that they are heading toward shuttered state parks and DMV offices, as well as furloughs for state workers, they have a way of getting their act together.

That's what happened in Kentucky in 2002 and 2004, when the biennial budget was months late twice in a row. As lawmakers squabbled, the governor took it upon himself to keep the government functioning. During the 2004 debacle, however, the state was sued on the grounds that its constitution doesn't give the governor power to appropriate money without a budget. The courts agreed. Since then, with lawmakers knowing that a late budget is likely to mean a government shutdown, they have gotten their work done on time.

Of course, a timely budget and a good budget are not always the same thing. State legislatures tend to be at their least transparent when they're rushing to meet a deadline. They also tend to make critical decisions without much deliberation. "If you want legislation done quick and dirty," says John Cape, a former New York budget director, "you'll get it done quick, but it will be dirty."

For many states, the only practical answer may lie in having the executive branch plan further ahead. That's what Michael Masch advocates. He has a unique perspective. Until last year, he served under Rendell as Pennsylvania's budget secretary; now he's on the other side, as Chief Business Officer of the Philadelphia school district.

What really hurts, in his view, is surprise. "The problem, Masch says, is when the final budget turns out to be materially different than what the governor proposed. In those cases, school districts that have been working on their budgets since Thanksgiving find themselves at the whim of legislators who interfere with their long-term plans. Masch would like Pennsylvania to commit itself to a funding formula and a five-year plan to pay for education. Then, he says, he would have a sense of what Philadelphia schools could afford and what they couldn't--even if lawmakers squabbled all summer.

Josh Goodman
Josh Goodman  |  Former Staff Writer
mailbox@governing.com  | 

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