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States' Financial Practices Get Graded

And the report card isn't good: Most states failed to balance their budgets without resorting to one-time fixes or underfunding pensions, among other violations.

<a href="">(Shutterstock)</a>
Most states are required to pass balanced budgets. But since the Great Recession, that's gotten harder and harder to do as states have been forced to reduce and reallocate spending. According to a new report from the Volcker Alliance, a nonprofit dedicated to effective government, "The potential to defer or obfuscate in making these adjustments is very real."

So to keep them honest, the alliance is grading all 50 states on their financial practices. In the first of what is expected to be an annual report, the findings aren't pretty: Most states skimped on at least one major area of the budget, and some earned nearly failing grades in almost every category.

The report grades states in five critical areas: forecasting accuracy; oversight and use of rainy day funds and other fiscal reserves; use of one-time fixes; adequately funding employee pensions and other benefits; and disclosing budget and related financial information.

The area in which states collectively performed at their worst was long-term liabilities, such as pensions and retiree health care. States face nearly $2 trillion in these unfunded liabilities. The report dinged 19 of them with a D or D-, the lowest grades possible. "Those legacy costs are the millstone hanging around a lot of states' and cities' necks right now," says William Glasgall, who helped co-author the report.

States performed best when it came to avoiding one-time gimmicks to balance the budget. Nearly half (22) earned an A. Still, the report noted that over the course of the last three years, 80 percent of states relied at least once on a one-time maneuver to keep their budgets balanced.

The average grade earned for nearly all five categories was a B; states averaged a C grade for managing their long-term liabilities.

With the report, the Volcker Alliance joins credit ratings agencies in handing out grades to states. But while the credit rating agencies consider many of the same budget factors the alliance report does, the ratings are ultimately a measure of a government's likelihood of default, which is not the same as having one's fiscal house in order.

Take Illinois. The state went two years without a budget and saw multiple downgrades from ratings agencies. But it was still able to float bonds and easily find buyers because no state in the modern era has defaulted on its debt. "There's no reasonable risk of a state actually defaulting," Matt Fabian, a principal at Municipal Market Analytics, which consulted on the report, said at the report's release. "But you had the governor and legislature acting in completely unpredictable ways that belied the understanding of almost anyone. So, the bonds of Illinois ended up trading almost like a day stock which is terrifying to anyone in the market."

Not surprisingly, Illinois is one of two governments that earned a D or lower in all but one category. It and Kansas both earned Bs in the financial transparency category.

The report offers several policy recommendations, including having clear policies for withdrawing money from rainy day funds and other fiscal reserves; implementing rules for replenishing those funds; tying the size of fund balances to revenue volatility; and adopting a consensus approach to budget forecasting to reduce political influence. On that last item, the report highlights as a best practice Washington state's Economic and Revenue Forecast Council, which includes representatives of the legislative and executive branches, as well as the state treasurer.

When it comes to budget transparency, the report found that while all but four states have a budget website, few actually contain the necessary data to help policymakers and advocacy groups make informed decisions. The report praised Colorado's website because it includes things like budget documents and instructions, budget amendments, fact sheets, archives, and information from past years. Alaska and California stood out as well for being the only two states to earn an A in the category because they are the only ones that disclose the estimated cost of replacing depreciated infrastructure.

Hawaii, Idaho and Utah received the most As. They all earned an A in avoiding one-time fixes. Idaho and Utah received an A for legacy costs, while Hawaii got an A in budget forecasting. But the rest of their grades are a mix of Cs and Ds. It shows, says Glasgall, that no state is perfect. "Many are good," he says, "and some are very challenged."

Liz Farmer is a former GOVERNING fiscal policy writer.
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