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The Biggest Finance and Management Issues to Watch in 2024

State budgets are on track for modest growth even as federal fiscal recovery funds wane, pension underfunding persists and AI promises (or threatens) to change everything.

a building sign that says "general public loans money in 1 day"
(David Kidd for Governing)
Editor's note: These issue briefs originally appeared in our annual Issues to Watch, which was published on Jan. 10. You can read the entire article here.


AI



Artificial intelligence has been around since the 1950s, but its sudden emergence as a consumer product and its potential to disrupt nearly every activity and industry has state lawmakers scrambling to address it. A dozen states have already enacted laws demanding agency research of AI and its use and consequences, while half the states have introduced bills to address its application both in government and the broader economy.

AI has incredible potential for handling data, automating repetitive tasks and generally making many functions easier for humans to handle. But lawmakers at this point are rushing to get ahead of possible downside risks. President Joe Biden issued an executive order laying out guidelines for “safe, secure and trustworthy use” of AI in October, while the European Union reached agreement on a sweeping set of policies last month.

In September, California Gov. Gavin Newsom directed state agencies to develop guidelines for state use of generative AI. This month, state Sen. Bill Dodd introduced a bill that would require state agencies to alert users when they are interacting with AI, while encouraging the state to invest in AI education and build capacity for its usage in the workforce.

Many of the conversations center on AI’s impact on everyday people — such as the case of teens facing exploitation from generated images. Expect to see further legislation like last year’s bill in New York banning explicit deepfakes of people. But the push for regulation is expanding into the political sphere. States including Florida, New Hampshire and South Carolina are considering legislation to limit or bar use of manipulated videos known as deepfakes around elections. “I think AI will be used in presidential election campaigning,” says Michael Ahn, a public policy professor at the University of Massachusetts Boston. “There will be active collection and usage of voters’ information for more effective political campaigning. However, that will come with potential privacy violations.”

The question of who owns the data used in AI has made for a lively set of legal challenges. Elected officials will be concerned with putting limits on public information. But tech experts say they should not rush to hamper tools that are still being developed. “There is likely an equal, if not greater risk of unintended consequences from poorly conceived legislation than there is from poorly conceived technology,” Daniel Castro of the Information Technology and Innovation Foundation said in response to the EU package. “And, unfortunately, fixing technology is usually much easier than fixing bad laws.”

—Zina Hutton


Budgets



The flood of federal funds that brought double-digit growth and record surpluses to state budgets in recent years is receding, but fiscal 2024 state budgets generally reflected a return to business as usual with modest growth in spending.

States have long been aware that federal aid would have an end date, says Kathryn White, director of budget process studies for the National Association of State Budget Officers (NASBO). They have largely used fiscal recovery funds for one-time investments, or investments that could strengthen their fiscal resiliency. Even so, the combination of reduced federal aid and decreased tax revenue could create challenges.

NASBO expects rainy-day fund balances to be higher at the end of fiscal 2023 than the year before, but for total balances (rainy-day funds plus general fund ending balances) to decline in 2023 and 2024. State tax revenue is anticipated to decline by 0.3 percent in fiscal 2023 and 0.7 percent in fiscal 2024, but a Pew analysis found that in most states revenues remain higher than they were pre-pandemic.

Meanwhile, there are continuing pressures on spending. The volatility of the insurance market is a big concern, says Shayne Kavanaugh, senior research manager for the Government Finance Officers Association (GFOA). Protection against cyber attacks — or natural disasters such as extreme heat events, wildfires, floods and hurricanes — could become unaffordable, if not unobtainable, for some jurisdictions. Inflating medical costs are another wild card.

Pressure is growing for bigger investments in affordable housing, support services for immigrants and technology upgrades. Salary increases may be necessary to rebuild a depleted workforce. Local governments will need to adjust as federal funds for schools and child care wind down.

The budget process depends on building productive conversations around conflicting interests, says GFOA’s Kavanaugh. Political conflict at the national level has already changed the tenor of conversations in state and local governments, and he’s concerned that this will only get worse as political battles intensify in this election year. “That’s not going to bode well, he says, “for wise or savvy decisions about budgets or in public finance generally.”

Carl Smith


Pensions



Pensions remain a trillion-dollar problem. States have improved the health of their pension plans over the past decade, but many remain badly underfunded. Last year, pensions enjoyed an average return on their investments of 7.5 percent. Partly as a result, average funding ratio for state and local pensions is projected to increase to 78.1 percent, up from 74.9 percent, according to the Equable Institute. Although the funding shortfall went down last year, it still stands at $1.44 trillion.

At this point, no state is deep in the danger zone — meaning none are unable to meet their current obligations. (Several were at risk of this just a few years ago.) But even though states have increased their pension contributions collectively by 7 percent a year since 2008, 21 states are still not making contributions large enough to keep their funding gaps from growing, according to the Pew Charitable Trusts.

The share of state and local government spending devoted to pensions now exceeds 5 percent, which is markedly higher than it was at the dawn of the 21st century. “Ultimately, pension funds are on a better trajectory than they were before the global financial crisis” of 2008, says Jean-Pierre Aubry, Associate Director of State and Local Research at Boston College’s Center for Retirement Research.

That being said, states still need to prepare for future periods of instability, making plans that take into account economic downturns. “A very promising practice that now half the states are doing is stress testing, asking what will pension plans look like if investments do worse than expected,” says David Draine, Pew’s principal investigator for public sector retirement systems. “Now states are able to plan for what a bad [financial] time might result in, and make policy changes to avoid excessive risks – or realize that the test is showing you that your current policies are sustainable, and that you're in great shape.”

States have been moving new hires into defined-contribution plans, along the lines of 401(k)s, leaving fewer employees left in the old defined-benefit pension programs. Although intended as a cost saving measure, there are now challenges for states that have few active employees left to pay into the old system. As states wrestle with workforce shortages, this is an area where at least some policymakers are exploring a restoration. Last summer, Kentucky Democratic Gov. Andy Beshear called for a defined-benefit plan for state troopers. “There was a mass exodus of troopers and officers when the defined benefits were taken away, understandably,” Beshear said. “A pension is a promise that I will always keep.”

Kentucky pensions have long been among the nation’s worst-funded. Discussing the upcoming budget, state House Speaker David Osborne said it would be “appropriate to assume that there will be significant additional contributions into the pension system.”

— Zina Hutton


Taxes



Both red and blue states have cut tax rates in recent years. The trend of cutting both personal and corporate income tax rates slowed but didn’t stop in 2023. “It’s a trend that stands out in recent history,” says Jared Walczak, vice president of state projects at the Tax Foundation. “We’ve never had a period with that many [state tax cuts] in such a short time and no other issue has caught fire quite like that.”

Many states were flush with surpluses thanks in large part to federal COVID-19 relief payments, and lawmakers sought to return some of that cash to taxpayers. The effects of their choices will start to become clear over the next few years. With revenues starting to decline, it’s possible the pendulum of state tax policy could swing the other direction. One exception could be property tax rates. With home values spiking, some states could seek to adjust rates to give homeowners a break. But in terms of income, some Democratic lawmakers are still pushing to increase taxes on the wealthiest citizens. This year, Massachusetts will enact its first state budget that includes proceeds from a tax on millionaires that voters approved in 2022.

In Minnesota, the Democratic-Farmer-Labor majority came close last year to adopting a so-called worldwide combined reporting rule, a complex change that would allow the state to collect corporate taxes based on companies’ overall global profits. It’s a hotly debated concept, with potential drawbacks as well as benefits for states. Minnesota would have been the only state in the U.S. to fully adopt it, but other states, including New Hampshire and Vermont, are considering similar rule changes in 2024. It’s an obscure tax policy that could either gain steam or fizzle out, depending on economic and political conditions.

—Jared Brey


Workforce



The United States continues to experience workforce shortages. If every unemployed person found a job, there would still be 3 million unfilled openings, according to the U.S. Chamber of Commerce. This ongoing labor shortage, which certainly extends to the public sector, is being driven by several factors, including pandemic-related burnout, an ongoing wave of baby boomer retirements in the public sector and a decline in the number of adults overall who are participating in the workforce.

Total public-sector employment remains below the level it had reached at the beginning of 2020, just before the pandemic. Cities, counties and states are struggling to compete with private-sector employers who are also actively recruiting and often able to offer salaries that the public sector can’t match. Earlier this year, the Police Executive Research Forum found that resignations were running 50 percent higher than before the pandemic. Nearly 90 percent of school districts struggled to hire enough teachers for the current school year. There hardly seems to be a job category without challenges. In December, the Board of Corrections in Arkansas asked Gov. Sarah Huckabee Sanders to activate the National Guard to help fill vacancies among prison guards.

Public-sector agencies are now seeking new strategies to broaden the applicant pool. Aside from raises, bonuses and flexible scheduling to retain current workers, 2024 will see an increase in skills-based hiring in the public sector, as opposed to demanding college degrees or other educational credentials, as employers re-evaluate hurdles blocking applicants from marginalized and underutilized groups, including young people and racial and ethnic minorities. A particular area of focus will be bringing in people with transferrable skills and experience from the private sector or other roles, making sure they get hired at the appropriate levels, rather than facing a career ladder reset.

Hawaii passed legislation last July to allow military spouses who follow active-duty personnel to the state to make it easier to use professional licenses from other states. That idea may well spread to other states this year, as public-sector agencies seek to better utilize the 13 percent of military spouses who are unemployed.

“One goal should be looking at nontraditional pools of people, maybe veterans, the Reserves, the National Guard, military spouses,” says Cara Woodson Welch, chief executive officer of the Public Sector HR Association. “It can be really hard for any of those groups as they're coming into the workforce. And the public-sector workforce is one of the premier places that really could use their services because they're already connected to a sense of mission and purpose.”

—Zina Hutton
Jared Brey is a senior staff writer for Governing. He can be found on Twitter at @jaredbrey.
Zina Hutton is a staff writer for Governing. She has been a freelance culture writer, researcher and copywriter since 2015. In 2021, she started writing for Teen Vogue. Now, at Governing, Zina focuses on state and local finance, workforce, education and management and administration news.
Carl Smith is a senior staff writer for <i>Governing</i> and covers a broad range of issues affecting states and localities. He can be reached at carl.smith@governing.com or on Twitter at @governingwriter.
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