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Is Your State Prepared for the Next Economic Bust?

A new S&P report ranks how states have recovered from the recession and warns some states about policies they're pursuing.

It may not feel like it, but the past five years have been a period of economic expansion. That means that states that have not adjusted their budgets to the economic cycle will have a very rude awakening when this “boom” period ends, as it will.

“It’s been a slower expansion than we’ve seen in the other economic growth periods since World War II,” says Gabriel Petek, an analyst for Standard & Poor’s who co-authored a recent report on states’ fiscal recoveries since the financial crisis in 2008. He says that since the recession, many states have kept funding of programs at highly constrained levels even though the economy has technically been expanding. “But [those funding levels] are not really doing much in the way of enhancements or not even really restoring what many of the policy advocates might suggest are necessary.”

Petek’s report notes that the eight recessions that have occurred since 1961 happen, on average, once every 6.6 years. The U.S. economy has been growing -- albeit slowly -- since 2009. Most state revenue forecasts assume the expansion will persist; S&P is calling for a modest acceleration through this year and the next. The 6.6-year reference is by no means a rule, says Petek. But trends indicate that budget planners should consider economic cycles in their forecasting. This week, early figures released by the Rockefeller Institute of Government’s State Revenue Report show that tax revenue growth is slowing in 2014. And the nation’s economic growth stalled during the first quarter of the year, creeping along at a mere 0.1 percent growth. (The lower-than-expected rate was partly due to bouts of harsh winter weather across the country this year.)

“State fiscal managers have to do more than take their best guess at the economy,” says Petek. “They also have to have contingencies for alternative scenarios. It’s something we can’t overlook in relation to the current expansionary phase.”

So which states are prepared? S&P uses three measures to determine a state’s progress in its fiscal recovery: 1) whether or not general fund or operating fund balances are equal to or greater than the state forecast for the end of the 2014 fiscal year, 2) whether rainy day fund balances have been restored to at least their 2008 level, and 3) whether a state is funding its actuarially recommended pension contribution.

Based on those standards, six states are in the positive for all three categories: Indiana, Michigan, Rhode Island, South Carolina, Utah and Wisconsin. Most states have recovered in at least two categories. Three (Kentucky, New Mexico and Pennsylvania) have not recovered at all, using S&P’s scoring. (Petek notes Illinois and New Jersey are running into budget balancing issues and may end their fiscal years with lower fund balances. That would place them in the “not recovered” group.)

There are notes of caution for 2015, namely that states considering tax breaks may place themselves in a precarious position. The report notes, for example, that Wisconsin’s new round of income and property tax cuts could reduce the state’s projected fiscal 2015 ending balance by 70 percent and create a new structural gap. Complicating this picture is the fact that 36 governors are up for election in 2014 -- creating an even greater temptation for some to push through tax reduction legislation to appeal to voters.

Although many states are suffering from austerity fatigue, easing up now could prove to be a misstep. And for the states that have not made significant progress in their post-recession recoveries, they have likely missed an opportunity, the report says, to prepare for the next downturn.

“This is no time,” says Petek, “to relax the grip.”

Check out the ranking here.

Liz Farmer is a former GOVERNING fiscal policy writer.
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