State Balanced Budget Requirements: Provisions and Practice

Ronald K. Snell
1996; updated 2004

Introduction

Elected officials and voters share a conviction that state budgets are supposed to be balanced; voters expect as much, and legislators and governors act on that rule. And in fact, state budgets generally are balanced, as annual reports from the National Conference of State Legislatures and the National Association of State Budget Officers show and as long-term statistical analysis has confirmed.

What is meant by a balanced budget is not as certain as it may seem intuitively. Even the number of states that must balance their budgets can be disputed, depending on the way the requirement is defined. Although the National Conference of State Legislatures (NCSL) traditionally says that 49 states must balance their budgets, it would be more precise to say that 49 states have at least a limited statutory or constitutional requirement of a balanced budget. This report examines the following topics:

• The nature of state balanced budget requirements
• What is meant by "balanced budget"
• Compliance with balanced budget requirements
• Comparison of state balanced budget requirements with the proposed federal constitutional amendment

Finally, this document includes, in an Appendix, the language of the constitutional and statutory provisions that officials in each state regard as establishing the balanced budget requirement in their state.

This report is based on a wide variety of sources, as the footnotes acknowledge, but it particularly draws upon work Marcia Howard did for the National Association of State Budget Officers. Corina Eckl, Hal Hovey, Marcia Howard, Scott Mackey, and Brian Roherty have provided helpful comments and suggestions on various drafts of this paper.

1. The Nature of State Balanced Budget Requirements

Some states have strict, explicit balanced budget requirements that force policy makers to ensure that expenditures in a fiscal year are within the cash available for that fiscal year. In other states, the requirement is derived from a constitutional limitation of state indebtedness or some other budgetary provision such as Virginia's constitutional requirement that the governor keep spending within revenues, and may lack a binding enforcement mechanism. In some states, of which Michigan is an example, constitutional provisions that are designed to prevent budget deficits allow unavoidable deficits to be carried to the next fiscal year for resolution. Vermont , uniquely, has no constitutional or statutory requirement for a balanced budget.

Not all states have constitutional language that clearly requires a balanced budget and many even lack explicit statutory requirements. The General Accounting Office has commented that "some balanced budget requirements are based on interpretations of state constitutions and statutes rather than on an explicit statement that the state must have a balanced budget." GAO's observation is supported by appendix B, which prints the language that legislative staff in 49 states have identified as the constitutional and statutory balanced budget requirement. The link between the constitutional or statutory language and a balanced-budget requirement can be obscure.

Whatever the source of the requirement-constitutional, statutory, or traditional interpretation-there are three general kinds of balanced-budget requirements, with differences of detail within each kind:

• The governor's proposed budget must be balanced;
• The enacted budget must be balanced;
• The budget must be balanced at the end of a fiscal year or biennium (no deficit can be carried forward).

Table 1 shows the extent of these general requirements for the states and Puerto Rico.

Constitutions in 32 states and Puerto Rico require that their governors' budget proposals must be balanced. There are similar statutory requirements in 11 more states. These are examples of the constitutional requirements:

Illinois:

The Governor shall prepare and submit to the General Assembly... a State budget for the ensuing fiscal year....Proposed expenditures shall not exceed funds estimated to be available for the fiscal year as shown in the budget.

Missouri:

The governor shall, within thirty days after it convenes in each regular session, submit to the general assembly a budget for the ensuing appropriation period, containing the estimated available revenues of the state and a complete and itemized plan of proposed expenditures of the state and all its agencies, together with his recommendations of any laws necessary to provide revenues sufficient to meet the expenditures.

These examples make two important points about the requirement that governors' proposed budgets must be balanced: (1) the governor's recommendation depends on a revenue forecast that may or may not be accurate, and (2) in some states (if not in all) governors can balance their proposed budgets by recommending additional revenue sources or tax increases. For example, the budgets recommended by the governors of California and New York for fiscal year 1997 depended on the passage of favorable federal legislation to bring them into balance. Such issues are also involved in requirements that legislatures enact budgets that are balanced.

Prohibitions against carrying deficits into the next fiscal year are a way of enforcing the principle of a balanced budget, since without debt it would be impossible for expenditures to exceed revenues. At least 12 states lack a prohibition on resolving an end-of-year deficit by borrowing, as shown in table 1. A survey by the General Accounting Office found that 21 states may carry a budget deficit forward from one fiscal year (or biennium) to another "if necessary."

The stringency of state requirements varies substantially. In 1984 the staff of the Advisory Commission on Intergovernmental Relations evaluated state balanced budget requirements on a scale of 0 to 10, with 10 indicating the most rigorous requirement. For a score of 10, a state had to have a constitutional prohibition against carrying a deficit forward and requirements that the governor propose and the legislature pass a balanced budget. Twenty-six states scored a 10, and 10 more states scored either eight or nine points. According to this evaluation, 36 (two-thirds) of the states had rigorous balanced budget requirements. The low-scoring states tend to have only a statutory or constitutional requirement that the governor submit a balanced budget, but not that one be enacted. Figure 1 shows the 26 highest-scoring states and the four with scores of 3 or less. In California , the voters approval of constitutional amendments in 2004 to require the legislature to enact a balanced budget and to prohibit borrowing to manage an end-of-year deficit moved California into the "most rigorous" category.

Figure 1. Stringency of State Balanced Budget Requirements

Source: Advisory Commission on Intergovernmental Relations

2. What Is A Balanced Budget?

In the 49 states that have a balanced-budget requirement, legislators and governors focus on balancing the general fund budget without as much emphasis or concern for balance in the rest of or the entire the state budget. Why this is so can be explained with a review of the role that state general funds play in overall state finances.

State governments practice fund accounting, which means that all state revenues are designated to be deposited in a particular fund and that every item of expenditure comes from some particular fund. The practice has survived from the 19th century, when unified state budgets did not exist, and most revenues were earmarked for some specific expenditure.

The most important fund is the general fund, which in almost every state receives almost all tax and fee collections, interest income, and collections from minor or occasional sources (forfeitures, gifts, inheritances and the like), but not, as a rule, federal grants-in-aid. Most legislative appropriations are made from the general fund. The general fund budget is the focus of public attention to state budgeting, because the appropriations process is an element of the policy making process--at times, the dominant element. Balancing the general fund budget is what is commonly meant by balancing the state budget.

State general funds receive 50 percent to 60 percent or more of state revenue collections from all sources. Thus there are large amounts of money outside the general fund. In almost every state, federal funds are separate from general funds. Motor fuel tax collections in most states are deposited in a separate highway or transportation trust fund. It is not uncommon for other separate funds to exist, each with a specific source of revenue and specified purposes for which the revenue will be spent.

The general fund budget receives more attention than the rest of state budgeting in part because there are few annual decisions to make about the rest of the budget.

• Almost all federal reimbursements or grants in aid to a state are committed to specific purposes, and the governor and legislature have little discretion over the use of most federal funds.
• Transportation trust fund money raised from state motor fuel taxes is usually earmarked for highways and other transportation purposes.
• Some tax collections may be directly apportioned to local governments or other specified purposes without appropriations.
• Some states allow agencies or programs to collect and spend fees, charges, or tuition without annual or biennial appropriations.
• Capital expenditures (discussed at greater length below) may not be part of the general fund budget.

The point to be made about each of the items listed above is that it is practically impossible for revenues and expenditures to get out of balance, since expenditures are controlled by available funds. Thus it is not surprising that the focus of "balancing the budget" tends to be on the general fund although general fund expenditures may make up only around 50 percent of total state spending. Despite this widespread view, state constitutional and statutory requirements for a balanced budget cover more than half of state total budgets in 45 states (see table 2).

Of particular interest are the types of funds that balanced budget requirements affect. While the general fund is specified in 48 states, in many states capital budgets are included as well (table 3). Other funds that some states include are various trust funds, federal funds, and special funds. Highway or transportation funds are the best-known example of a trust fund. Federal funds include block grants, highway construction funds, and reimbursements for Medicaid expenditures. Special funds refers to funds such as those receiving revenues earmarked for education, local government aid, or some other specific purpose.

Reserves

State governments usually plan to carry cash reserves from one fiscal period into the next. Whether the reserve is in a formal rainy day fund or not, it is intended to facilitate cash management and to make up possible shortfalls in revenue (the specifics vary greatly from state to state). Reserves are part of the annual equation, therefore. A state can have a balanced budget despite a revenue shortfall if reserves are available to make up the difference.

Restrictions on borrowing cause state governments to hold reserves to deal with revenue shortfalls and cash management issues that businesses would cover with short-term borrowing. Borrowing is not a routine matter for state governments. In some states, executive branch officials have limited authority to initiate short-term borrowing for cash-flow purposes, but in many states even short-term loans cannot be sought without legislative approval. In addition, only a few states can undertake long-term borrowing (for more than one year) without voter approval. The alternative is to maintain reserves.

Reserves are so important a part of state finance that both the National Conference of State Legislatures and the National Association of State Budget Officers measure them annually. Reserves measured as a percentage of state spending are the most useful simple measurement of state fiscal well-being. A reserve of 5 percent of budgeted expenditures is a conventional standard of adequacy, although what is appropriate for a specific state will depend on circumstances.

Capital expenditures

State governments borrow substantial amounts for capital expenditure, a practice that sometimes leads observers to the conclusion that state budgets are not in fact balanced. How is this practice reconciled with the contention that states do balance their budgets?

The common state practice is to consider that borrowing for capital expenditure does not violate the principle of maintaining a balanced budget. Borrowing for capital expenditure does not legally violate state balanced budget provisions, either because those provisions specify a way that general obligation debt may be issued, or because, in states that do not permit general obligation debt, caselaw has validated the issuance of other forms of debt. In some states, general obligation debt requires a constitutional amendment.

Most state governments, unlike the federal government, have separate operating and capital budgets. Operating budgets rely upon continuing (annual) revenues. A growing amount of state capital finance comes from the issue of debt. It is extremely rare for a state government to borrow in the long term (for more than one year) for operations expenditures. The circumstances in which states have done so in the past decade demonstrate the rarity of such borrowing.

The Louisiana Economic Recovery District. In 1988 Louisiana was faced with an accumulated multi-year state deficit in operating accounts which it had been covering by internal borrowing from other state accounts and by deferring vendor payments. Because the state constitution prohibited the use of state long-term debt for such a purpose, the state established a special district called the Louisiana Economic Recovery District to issue the debt. The Recovery District encompasses the entire state. It levied a 1 percent sales tax which is in effect throughout the state. The tax has been used to support the issuance of $982 million in bonds, the proceeds of which have been deposited to the credit of the state general revenue fund. The bonds will be repaid by 1998.

The Connecticut debt retirement fund. At the end of FY 1991, the state of Connecticut had accumulated a deficit of $966 million in its general fund, largely because of that year's revenue shortfalls but including a shortfall of $157 million carried forward from FY 1990. Legislation enacted in 1991 provided for the issuance of general obligation Economic Recovery Notes to amortize the deficit over five years, and for a Debt Retirement Fund as a repayment mechanism. Funds for repayment of the bonds come directly from tax receipts which otherwise would be credited to the general fund. The state has maintained the scheduled repayment of the bonds.

Do state governments otherwise finance operations with long-term debt? There is no conclusive answer to that question, although it seems unlikely that the practice is extensive, even if there may be other examples than the two just mentioned. The only comprehensive time series of figures on state finance, the numbers published by the Bureau of the Census, do not offer enough detail to answer the question, and it does not appear that anyone has examined state annual financial statements for the answer. Two pieces of evidence argue that states do not use long-term debt to finance operating expenditures.

In recent years, states with intractable budget problems (like California) have found short term debt and rolling shortfalls forward from one year to the next to be enough to deal with the problem.

It is unlikely a state government could do so without proponents being attacked politically for unsound fiscal practices. Unlike the federal government, state governments do not have the luxury of borrowing money routinely and quietly.

3. Compliance With Balanced Budget Requirements

State balanced budget requirements matter. States that have the most rigorous requirements for a balanced budget are the most likely to balance their budgets. States with less rigorous budgeting requirements make use of them. These outcomes tend to occur even though most states lack strong enforcement mechanisms.

Although there is generally no legal mechanism to force compliance, 22 states report the existence of an enforcement provision. Many of them specify the constitutional provision itself as the enforcement mechanism. States with more specific provisions frequently cite statutory requirement that hold certain officials liable for imbalances. Some states--Alabama and Oklahoma are examples--require mandatory expenditure reductions to keep budgets in balance, but this requirement is rare.

Three examples follow of constitutional enforcement provisions. It is not clear that legal measures envisioned in the Alabama citation have ever been taken against a state official for failure to keep a state budget in balance. A substantial number of states allow or require governors to reduce state spending when it is likely to exceed available resources, along the lines of the Minnesota and North Carolina provisions quoted below. (NCSL has published a study of the means that states use to prevent budgets from becoming unbalanced in the course of implementation, Legislative Authority over the Enacted Budget.)

Alabama. The state constitution provides that claims against appropriations become void at the end of the fiscal year if the treasury lacks money to pay them. A treasurer who violates this provision is subject to a $5,000 fine, two years' imprisonment in the state penitentiary, or both, as well as impeachment.

Minnesota. Deficits are to be avoided by reducing unexpended agency allotments even if it is necessary to defer or suspend statutory obligations to do so.

North Carolina. The constitution requires that the governor "shall continually survey the collection of the revenue and shall effect the necessary economies in State expenditures" whenever he determines that revenues and reserves will not meet budgeted expenditures.

Restrictions on state indebtedness are a powerful inducement to balance budgets. At least 16 states require voter approval of general obligation debt. The constitutions of at least five states prohibit debt altogether (although a constitutional amendment could create an exception, and this is the method used to express popular approval of indebtedness in some states). Long-term indebtedness generally requires legislative approval for specific instances. No state emulates the federal practice of legislatively capping the amount of indebtedness and allowing the executive branch to borrow routinely. As a result, every state issuance of general obligation debt occurs in the political arena.

Revenue bonds and short-term debt generally can be issued without legislative or popular votes. Since they generally have to be linked to a project or service that will provide the funding to liquidate them, they are not generally a likely source of direct funding for a state shortfall. Sales of state assets to public authorities in Northeastern states in the early 1990s (to gain cash to help balance general fund budgets) were sometimes linked to the issue of revenue bonds, however. Authorities--a state turnpike authority for example--might be able to issue revenue bonds to cover the cost of buying a state asset, such as a highway, to make cash available to state government.

For the majority of states, however, the most important factor contributing to balanced budgets is not an enforcement mechanism or a provision specifying how a shortfall will be resolved. Rather it is the tradition of balancing the budget, which has created a forceful political rule that the budget will be balanced. Although states with enforcement provisions emphasize their importance, the expectation that state budgets will be balanced is the most important force in maintaining a balanced budget.

4. Comparison Of State Balanced Budget Requirements And Proposed Federal Constitutional Amendment

State balanced budget provisions are not as restrictive as those a proposed constitutional amendment would impose on the federal government. The proposal for a federal balanced budget that the US House of Representatives adopted in 1995 would limit federal spending for a fiscal year to federal receipts for that year. No long-term borrowing would be possible for the federal government except for the specific purpose of refinancing existing debt.

Adoption of this amendment would prohibit the federal government from two practices that are integral to the states' approach to balancing their budgets--the use of reserves from previous years and the use of separate operating and capital budgets.

In a very general, non-technical sense, a state budget is balanced if expenditures do not exceed available revenues (taxes and other revenues that will be collected during the budget period, unspent funds from the past, other state reserves, and possibly other sources of revenue). This is different from the proposed federal requirement in that the federal proposal does not allow for the use of carryover or reserves from past years. The federal general fund would not carry a reserve from one fiscal year to the next. If at some future date a federal surplus should materialize, it would not be held as a reserve but would be used to reduce the accumulated federal debt.

The proposed federal amendment makes no provision for budgeting for capital expenditures separately from operations costs, and would prohibit the issuance of debt for both purposes. States that operate under similar strictures sometimes use constitutional amendments to issue general obligation debt and often allow the issuance of revenue bonds to provide for capital investment. It does not appear that the proposed amendment would permit the federal government to issue revenue bonds, although it is impossible to say what powers would still remain for federal authorities and semi-independent agencies. Federal constitutional amendments to authorize debt would be impractical because of the length of time involved and the super-majority requirements that a federal constitutional amendment must meet.

5. Conclusion

Constitutional and statutory provisions requiring balanced budgets are often unclear, making it impossible to count the different kinds of requirements with precision. Some state requirements that governors and legislators regard as binding have emerged over time through judicial decisions based on constitutional provisions that appear to have little to do with budgets. Not only is it difficult in some states to determine the constitutional or statutory authority, but states often have no clear enforcement mechanism.

Considering the lack of specific constitutional mandates and enforcement structures, state compliance with the principle of a balanced budget is notable. Restrictions on debt play a part, but are an insufficient explanation for the fact that even states that can legally carry a deficit from one year to the next avoid doing so. It appears that the political convention that state budgets are supposed to be balanced is its own enforcement mechanism.

Sources

• Advisory Commission on Intergovernmental Relations, Fiscal Discipline in the Federal System: National Reform and the Experience of the States (Washington, D.C., 1987).
• Council of State Governments, Book of the States, 1994-95 edition (Lexington, Ken., 1994).
• National Association of State Budget Officers, Budget Stability: A Policy Framework for States (Washington, D.C.: NASBO, 1995).
• State Balanced Budget Requirements: Provisions and Practice (Washington, D.C.: NASBO, June 1992).
• __Limitations on State Deficits: Text of Constitutional and Statutory Provisions ( Lexington, Ken.: Council of State Governments, 1976).
• National Association of State Treasurers, State Treasury Activities & Functions (Lexington, Ken.: Council of State Governments, 1994).
• Poterba, James M., "State Responses to Fiscal Crises: The Effects of Budgetary Institutions and Politics," Journal of Political Economy, 102 (August 1994): 799-821.
• U. S. General Accounting Office, Balanced Budget Requirements: State Experiences and Implications for the Federal Government (Washington, D.C.: GAO, 1995).

Posted April 1996, updated March 2004.
Email State Balanced Budget Requirements: Provision and Practice for more information.

Contents

• Introduction
• 1. The Nature of State Balanced Budget Requirements
• 2. What Is A Balanced Budget?
• Reserves
• Capital expenditures
• 3. Compliance With Balanced Budget Requirements
• 4. Comparison Of State Balanced Budget Requirements and Proposed Federal Constitutional Amendment
• 5. Conclusion
• Appendix: State Constitutional And Statutory Requirements For Balanced Budgets