Five Rules for State Appropriations
When we talk about budgets and fiscal policy, we almost always focus on the federal government. The themes are debt and deficit, ceiling and cliff, stalemate and rancor. In other words, doom and gloom.
But if you've been paying any attention to state finances, you've noticed the headlines are a whole lot more positive. Surpluses, expansions, new hires, and, yes, growth.
Indeed, at the state and local levels, budgets are the best they've been in some time. Nevertheless, considerable challenges remain -- and I'm not just talking about Detroit. As I argue in a new report for The Century Foundation, surpluses are not a cause for celebration. To the contrary, unexpected upticks in state fortunes may lull lawmakers into a false sense of complacency -- while hidden liabilities are accumulating at a frightening rate. My research suggests that when we consider broader measures of fiscal health, the conventional wisdom about strong states and weak states doesn't seem so wise at all.
Diagnosing problems is well and good, but problems require solutions. So without further ado, here are my five rules of thumb for state budgeters.
1. Don't celebrate surpluses.
If you ended up with a surplus, your prediction missed the mark -- and this looks especially bad if you achieved the surplus through painful cuts. Further, every dollar collected in taxes that isn't spent deprives the economy of a dollar that could have been used to generate economic activity.
No one likes paying taxes, but paying taxes that aren't even needed? Let's just say that'll make your approval ratings about as high as A-Rod’s in the Bronx.
Don't make things worse by getting cocky -- or greedy. Realize that these surpluses aren't here to stay, and keep your hand out of the cookie jar.
2. Get honest about long-term liabilities.
Pensions, retiree health costs, Medicaid: You have enough unfunded liabilities to run for office in Greece. Ignore these looming challenges at your own peril. Credit markets and voters are taking notice.
The State Budget Crisis Task Force, chaired by Richard Ravitch and Paul Volcker, offers helpful suggestions to improve budget practices. Foreswearing gimmickry is the first step. Things like one-time asset sales, gutting designated trust funds, securitizing future revenues, and issuing pension-obligation bonds have a tendency to compromise future budgets in compounded fashion.
A frequent co-conspirator in such machinations is cash accounting, which counts revenues and expenditures when payments occur rather than when services are performed. Shifting payments across periods conceals deficits but undermines long-term solvency. Accrual accounting, by contrast, imposes temporal consistency between incurring costs and paying for them -- and provides a more accurate portrait of the match between government resources and obligations.
Multi-year financial plans -- all too often absent -- provide a more complete picture of state financial conditions. Situating the current-year budget in the context of long-term assets and liabilities illuminates tradeoffs and facilitates decisionmaking. Similarly, multi-year appropriations can interject a measure of stability into state financial planning and insulate government services from political winds -- so long as processes for responding to crises are retained.
3. If you have a surplus, use it for one-time needs.
Baselining windfalls is a dangerous business. If revenues drop, you're driving your state off a cliff. People hate losses more than they appreciate gains. In this case, spending and cutting is worse than never having spent at all.
One-time revenues call for one-time spending. These types of expenses abound. Think emergency remediation or countercyclical caseloads. Less good ideas include giving teachers across-the-board raises, opening a new prison, or hiring more highway workers. Such ideas may have merit, but they require long-term funding solutions.
4. If you don't have one-time needs, now's not a bad time to invest in an umbrella.
I'm talking about rainy-day funds. Unlike the federal government, every state except Vermont is required to balance its budgets. Consequently, states have limited fiscal-policy options to deal with recessions.
With spending tied closely to volatile income and sales taxes, state budgets all too often become pro-cyclical, falling during recessions and compounding economic slowdowns.
As a result, increasing numbers of states have turned to rainy-day funds to cushion business-cycle shocks. Largely a recent invention -- 45 states have them today, compared with just 10 prior to 1980 -- these reserves, which are technically known as "budget stabilization funds," can add a countercyclical component to state spending. In good times, states put money away; when rainy days come, withdrawals smooth spending reductions.
Like most things, rainy-day funds took a beating during the recession. Worth 11.5 percent of state general-fund expenditures in 2006, balances fell to just 5.2 percent in 2010. They've bounced back a bit in recent years, and are expected to reach 9 percent of spending, or $61 billion, in 2013. However, just two states -- Alaska and Texas -- account for half the total. Overall, the balance for the remaining 48 is worth just 5 percent of those states' total spending -- the bare minimum experts consider useful -- and half of those states have less than that.
If you can't find one-time needs, now's not a bad time to make a down payment for the future. If you wait for a storm to buy an umbrella, you're gonna get wet.
5. Make sure your umbrella actually works.
As important as rainy-day funds are as fiscal stabilizers, many states use them sub-optimally. Three straightforward reforms suggested by the Center on Budget and Policy Priorities would go a long way towards helping these reserves achieve their purpose.
First, raising contribution caps -- which are artificially low in many states -- permits saving more when revenues are flush. Second, relaxing replenishment rules -- easing requirements on both the deposit and withdrawal sides -- increases the dexterity with which funds are used. Third, streamlining the process for releasing funds -- too often bound up in legislative politics or restrictive rules -- allows fiscal policy to be more responsive to current economic conditions.
Some observers, including economists at the Federal Reserve Bank of Chicago, have gone so far as to propose a national rainy-day fund. Such a fund would operate similarly to the federal unemployment-insurance fund, allowing states to borrow when necessary and requiring participants to conform to uniform rules, thus taking the politics out of economic stabilization while expanding resources. It's an idea worth considering.
* * *
America's fiscal future depends on strong states. The federal budget is in disarray, and with sequestration the flavor of the day in Washington, things are looking pretty bleak -- both for rational fiscal policymaking and for Congress's chances at opening a successful ice-cream business. The responsibility will fall to states.
State and local governments already account for an eighth of GDP and a seventh of jobs. They provide nearly all the services -- from police and sanitation to education and transportation -- that citizens expect of government. In the years ahead, they'll need to do all this, and more.
The road to fiscal sustainability is long and winding. These five rules provide a roadmap for beginning the journey. Let's just hope we've set aside enough money to fill the potholes.
Michael Cassidy is a domestic-policy blogger at The Century Foundation.
