Why States Should Take Budget Surpluses with a Grain of Salt

Many states ended fiscal year 2013 with a surplus, but experts warn that it doesn’t mean their financial woes are over.

As states compile their 2013 financial statements, a welcome trend is emerging: Many ended the fiscal year with a surplus. The figures weren’t a surprise (Governing and others predicted the string of surpluses months ago). But the news set off a flurry of questions, like what does a surplus mean, and does it even matter?

Scott Pattison, head of the National Association of State Budget Officers (NASBO), says that right now, it doesn’t mean much. He’s been urging leaders to temper their enthusiasm. For starters, he says, those surpluses are largely due to one-time revenue gains that were the result of many citizens shifting their taxable income from calendar year 2013 to 2012 in anticipation of the federal “fiscal cliff” late last year. Secondly, Pattison says, many budget officers were extremely cautious as they prepared their FY 2013 forecasts, given the sluggish economy of recent years. Those factors together made surpluses almost an inevitability in some cases.

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Moreover, the surpluses don’t mean state governments’ financial woes are over. Serious fiscal challenges remain. While state revenues and expenditures have returned to pre-recession levels, they’re still behind if you account for inflation. And NASBO isn’t forecasting much improvement in fiscal 2014 either, with projected general fund spending set to rise 4.1 percent and general fund revenue up 2.8 percent—both lagging behind historical growth trends.

So what’s a state to do if a surplus isn’t necessarily a harbinger of good news? Elizabeth McNichol, a senior fellow at the Center on Budget and Policy Priorities, says states would be wise to spend one-time revenue on one-time expenses like capital infrastructure projects, shoring up rainy day funds or paying down debts. Of course, that’s not always easy, since left-leaning lawmakers may be tempted to put that money back into programs that have been cut, and right-leaning lawmakers may want it put toward tax cuts. Case in point: Some California Democrats have called for funneling surplus dollars toward higher education, while some Wisconsin Republicans have cited their state’s surplus as justification for lower taxes. Both proposals can be risky, since they involve ongoing commitments based on money that could be only temporary.

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Part of the confusion for states is that they don’t know exactly how much of their surpluses are from long-term revenue growth, and how much is just due to last year’s one-time bump. A recent Goldman Sachs report says that of the 9.7 percent in states’ revenue growth in the first quarter of 2013—nearly the fastest since the recovery began, by the way—almost half could be from shifting tax burdens.

In Michigan, which this spring increased its two-year revenue forecast by nearly $700 million, the majority of the extra funds will go toward one-time road projects and the state’s rainy day fund, says budget director John Nixon. “As you start to run surpluses, you don’t want to build those into your base budgets,” Nixon says. “If you build those into your base budgets, then you’ll always be playing catch-up.”

Caroline Cournoyer is GOVERNING's senior web editor.