States are using gimmicks to hide their budget woes, but their fiscal problems are here to stay

July 17, 2012

The aftermath of the 2008 financial crisis showed just how vulnerable state budgets are to economic swings. The major loss of revenue from income, sales and property taxes, combined with pressing Medicaid and pension obligations, created a major fiscal crunch.

States responded to the fiscal crisis by slashing government jobs and services, as well as passing temporary tax increases. They also received a temporary boost from the 2009 federal stimulus. But many also resorted to budget gimmicks, accounting sleights of hand and one-shot fixes to close the gap. In a new report, a group of budget experts explains that such measures are merely masking—and sometimes even exacerbating—the fiscal crises that states will continue to face even after the overall economy comes back.

Led by former Fed chairman Paul Volcker and former New York lieutenant governor Richard Ravitch, the group describes how states relied increasingly on stopgap measures to balance their budgets, allowing them to avoid tough and politically unpopular spending cuts or tax increases. Examining six states as case studies, the report runs down the fiscal band-aids that state governments have resorted to using. Here's an excerpt from one of their tables:


(Excerpt from the State Budget Crisis Task Force's 2012 report)

New York, for instance, raided funds legally dedicated to other programs—welfare, environmental protection and wireless network improvements. Texas delayed school aid payments by a few calendar days so they would count toward the next year's budget. Virginia underpaid its contributions to the state and teachers' pension funds. New Jersey continues to make overly optimistic projections for tax revenue collection, as I explained last week.

Finally, New York, New Jersey, California and Illinois all issued bonds on a tobacco settlement payout intended to pay for health-care costs from smoking—a kind of securitization that "borrows cash not just from the year ahead but from many years into the future, causing future budget gaps to grow," the report explains.

States have also tended to understate their pension liabilities, the report argues, describing their financial reporting on the funds as "inadequately and confusingly disclosed." Rosy projections for pension investments have also clouded the fiscal picture: the California Public Employee Retirement System, the nation's largest public pension fund, recently reported a measly 1 percent return, majorly short of the 7.5 percent projected.

The problem with all these workarounds is that they allow states to simply put off and avoid their long-term budget problems, while the public largely remains in the dark:

Some states rely on nonrecurring items as an ongoing budget strategy. The just-enacted fiscal year 2013  California budget continues to rely heavily on nonrecurring revenues and gimmicks four years after the recession  ended and two years after the federal stimulus was phased out. Chronic dependence on nonrecurring actions, in good times as well as bad, can mask a growing mismatch between ongoing spending commitments and ongoing revenues, which allows voters to believe that they can continue to have desired services without higher taxes.

The report exhorts states to come up with more sustainable solutions to their budget dilemmas, as they ultimately won't be able to avoid the day of fiscal reckoning. State revenues have been slowing improving along with the rest of the economy. But Medicaid costs will continue to rise, whether or not states join the Obamacare expansion, massively underfunded public pensions will ultimately come due and federal deficit reduction measures could cut future spending on states, the group concludes.

The first step to solving states' long-term budget problems, however, is for them to admit more openly there's a problem in the first place.

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Ezra Klein · July 17, 2012