State Strategies to Manage Budget Shortfalls

December 1996

Preface and Acknowledgments

In mid-1991, several members of the Foundation for State Legislatures convened to discuss how they could assist in the development of sound state fiscal policy. They concurred that they could pool their resources to examine specific areas of state tax policy and then make recommendations. This group, known as the Foundation Fiscal Partners, supports the Fiscal Affairs Project, a continuing effort to increase, enhance and communicate state fiscal information.

One of the goals of the Fiscal Affairs Project is to improve the dialogue among state legislators, business representatives and other organizations interested in decisions on state fiscal policy. By increasing awareness of different perspectives and improving communication among the participants, these groups can develop an effective partnership to address such concerns as fair and stable tax systems and sound budgeting practices.

The Fiscal Affairs Project has supported the work of the NCSL Fiscal Affairs Program in several ways. Most notably, the project has produced three major publications: (1) Principles of a High-Quality State Revenue System; (2) Fundamentals of Sound State Budgeting Practices; and (3) this report, State Strategies to Manage Budget Shortfalls.

State Strategies to Manage Budget Shortfalls is the work of many contributors: legislators, legislative staff and representatives from the Foundation for State Legislatures. Besides drawing upon the expertise of those who directly participated, the NCSL staff who wrote this report relied on numerous state experts including several NCSL staff with substantive knowledge and expertise on specific state programs.

Corina Eckl, Scott Mackey and Ronald Snell are the principal authors of this report. Other fiscal staff contributing to this report were Arturo Pérez and Mandy Rafool. Any views expressed in this report are the responsibility of the authors and should not be attributed to the participating legislators, legislative staff or sponsoring organizations.

The authors wish to thank the numerous state experts and NCSL staff who provided case studies, offered substantive comments or reviewed sections of the report. These individuals were Don Judy of Kentucky's Legislative Research Commission, Bill Goodman of Arkansas' Bureau of Legislative Research, Liz Hill of California's Legislative Analyst Office, Diane Warriner of Pennsylvania's House Republican Appropriations Committee, Robert Bittenbender of Pennsylvania's Executive Budget Department, Sally Tubbesing of Maine's Legislative Council, Arthur Porter of New York's State-Local Relations Staff, Glen Tittermary of Virginia's Joint Legislative Audit and Review Commission, Betsy Daly of Virginia's Senate Finance Committee, Bill Sheldrake of Indiana's Fiscal Policy Institute, Mike Groesch of Washington's Senate Ways and Means Committee, John Walker of Michigan's Senate Fiscal Agency, Jeffrey Schmied of Arizona's Joint Legislative Budget Committee, Claire Drowota of Tennessee's Oversight Committee on Corrections, Susan Smith of Tennessee's Fiscal Review Committee and Robin Lubitz of North Carolina's Sentencing and Policy Advisory Commission. The NCSL staff assisting with this report were Julie Bell, Brooke Davidson, Martha King, Donna Lyons, Elizabeth Pearson, Laura Tobler, Jack Tweedie, Terry Whitney, Adelia Yee and Judy Zelio.

The authors also extend special appreciation to Carolyn Alvarez for her expert preparation of the text and tables for this report, to Karen Fisher for her comprehensive and precise editing and to Bruce Holdeman for his cover design.

Participating Legislators and Legislative Staff

Senator Ben D. Altamirano, New Mexico
Representative Jeannette Bell, Wisconsin
Dale Bertsch, Legislative Research Council, South Dakota
Paul Dlugolecki, Executive Director, Senate Minority Appropriations, Pennsylvania
Representative William R. Dyson, Connecticut
Representative Kathleen W. Gurnsey, Idaho
J. Donald Judy, Director, Office of Budget Review, Kentucky
Robert Keaton, Office of Fiscal Affairs, Louisiana
Alan Kooney, Legislative Budget & Finance Officer, Legislative Budget & Fiscal Office,
New Jersey
Robert Lang, Director, Legislative Fiscal Bureau, Wisconsin
Gary Olson, Director, Senate Fiscal Agency, Michigan
Dennis Prouty, Director, Legislative Fiscal Bureau, Iowa
Peter Schaafsma, Executive Director, Debt Advisory Commission, California
Richard Stavneak, Joint Legislative Budget Committee, Arizona
Irving Stolberg, former Speaker of the House, Connecticut
Representative Dan Troy, Ohio
Lee Van Riper, Director of Fiscal Studies, Senate Finance Committee, New York

Representatives of the Foundation of Fiscal Partners

American Express Company

Les Goldberg, Vice President, State Government Affairs
Stephen D. Lemson, Manager, State Government Affairs

American Federation of State, County & Municipal Employees

Marcia Howard, Economic Policy Analyst, Department of Public Policy
Ann Kempski, Economic Policy Analyst, Department of Public Policy
Marie Monrad, Associate Director, Department of Public Policy

National Education Association

Joseph A. Falzon, Research Specialist
Ed Hurley, Research Specialist

Philip Morris Management Corporation

Derek Crawford, Director, Government Affairs Planning
Pam Inmann, Regional Director, Government Relations
Tina A. Walls, Vice President, Government Affairs

Executive Summary

There are many causes of state budget shortfalls, and, because they are interrelated, several often arise simultaneously. The chief causes are weak economic performance, inaccurate revenue and expenditure projections, state tax policies such as excessive use of tax earmarking, state expenditure policies such as unchecked program spending, federal actions such as the imposition of unfunded mandates and court decisions such as those imposing substantial funding obligations on the states.

There are two kinds of budget shortfalls: (1) short-term, temporary shortfalls that result from economic cycles or imprecise revenue or expenditure forecasts and (2) structural shortfalls that result from expenditure growth routinely outpacing revenue growth.

Although policymakers' strategies to resolve budget shortfalls vary, they have a predictable pattern. State officials impose short-term or stop-gap measures, cut the budget, increase revenues or impose some combination of these strategies. Generally, the selection of a strategy depends on the amount of time remaining in the fiscal period, the severity of the shortfall and other actions that have been taken.

Short-term strategies are not intended to deal with fundamental budget problems and may generate only one-time savings or revenues. Their chief advantage is that they typically have an immediate effect on a budget problem. Examples of short-term measures include delaying payments to vendors, deferring tax refunds and accelerating tax collections.

States may also turn to temporary budget cuts to deal with shortfalls. Again, the impact is immediate because the level of state spending is adjusted to fall within estimated available revenues by the end of the fiscal year. Budget-cutting exercises also may provide policymakers with an opportunity to seriously review spending priorities.

Policymakers may opt to raise revenues to deal with budget shortfalls. These revenues may be one-time (e.g., revenue from tax amnesty programs) or long term (e.g., permanent increases in the sales tax rate).

To limit the need to cut the budget or raise taxes, many states have implemented procedures intended to avoid or minimize shortfalls. Among the most common measures are limiting appropriations to a percentage of revenue estimates, imposing contingency budget reductions or trigger mechanisms and creating budget stabilization funds.

In addition to short-term strategies to address budget shortfalls, states also may seek permanent spending reductions in major program areas. Most spending is for elementary-secondary (K-12) education, Medicaid, higher education, corrections and welfare. In combination, these program areas account for about 70 percent of state general fund spending. As a result, policymakers are apt to consider these areas when budget cuts appear inevitable. States have tried strategies that include reducing K-12 foundation aid, implementing Medicaid managed care programs, reducing state funding for higher education, privatizing prisons and implementing welfare reform.

State policymakers also consider expenditures that cut across program lines when implementing budget reductions. For instance, 20 percent of all state spending goes for government employees. To reduce personnel costs, states often implement early retirement programs or privatize certain services. State aid to local governments is another expense that crosses program lines. When looking for aid reductions, states have reduced general purpose revenue sharing or have identified another source of funding to replace state support.

This report explores a variety of strategies that states have used to manage budget shortfalls. It provides information, evaluations and case studies that policymakers can refer to when considering their options. Recommendations regarding which actions to take are not included because lawmakers must assess the potential effectiveness and political feasibility of various options in view of the social, economic and political context of their respective states.

Introduction

Budget shortfalls are an inevitable occurrence in government finance. Because revenues are tied to the business cycle, economic declines will cause revenues to fall. At the same time, demand for government services typically increases during economic downturns, often pressuring state officials to spend above budgeted levels. Even sound state fiscal planning and management cannot save states from dealing with the effects of business cycle declines, although they may minimize the adverse effects of those declines or buy a state time to make better informed fiscal decisions.

What Is a Budget Shortfall?

A budget shortfall occurs when spending exceeds revenues during a budgeting period (fiscal year or biennium). As discussed in greater detail in chapter 1, shortfalls occur because:

Revenues do not materialize as projected;
Spending exceeds originally appropriated levels;
Some combination of lower-than-expected revenues and higher-than-expected spending occurs simultaneously; or
State reserves or other potential revenue sources are insufficient to cover planned or unplanned spending.

This report is concerned with general fund budget shortfalls that have the potential of becoming year-end deficits. There are two kinds of budget shortfalls: (1) short-term/ temporary shortfalls that result from economic cycles or imprecise revenue or expenditure forecasts and (2) structural shortfalls that result from the growth of expenditures routinely outpacing the growth of revenues. This report reviews strategies for dealing with both kinds of shortfalls.

Purpose of This Report

Because most states operate under a constitutional or statutory requirement for a balanced budget, strategies to avoid a deficit are required in most states. The purpose of this report is to explore these strategies. Although fiscal crises can provide opportunities and options for dealing with the state budget that may have been rejected during times of fiscal stability, eliminating a budget shortfall is no easy task. This report will not make the task of addressing budget shortfalls any easier, but it provides useful information and evaluations as policymakers consider options to eliminate shortfalls. It also includes specific state experiences with those strategies.

This report does not make recommendations regarding which actions to take because lawmakers must assess the potential effectiveness and political feasibility of various options in view of the social, economic and political context of their respective states. Furthermore, this report does not attempt to assess the various philosophies on the appropriate role of government: The size of state government and the level of services provided are issues to be determined by the elected officials and citizenry of each state.

This report emphasizes strategies to manage budget shortfalls, which tend to need resolution within a short period of time. It also looks at some state actions that are intended to have a longer-term, positive effect on state budget management.

Short references to relevant publications are included in the text; full citations are contained in the Select Bibliography contained at the end of the report.

As previously noted, budget shortfalls often are the result of both revenue decreases and expenditure overruns, so state officials must consider both sides of the ledger when attempting to eliminate budget shortfalls. This report focuses only on budget strategies to manage shortfalls because good sources of information on revenue options already are available. State Tax Actions, an annual series of reports produced by NCSL, provides a comprehensive list of state tax actions over the past decade. Financing State Government in the 1990s also provides a comprehensive discussion of state revenue issues.

Continue to Chapter 1, Causes of Budget Shortfalls.

Select Bibliography

Eckl, Corina L. "States Broaden the Scope of Rainy Day Funds." The Fiscal Letter (National Conference of State Legislatures) 17, no. 2 (1995).
Eckl, Corina L. Legislative Authority Over the Enacted Budget. Denver, Colo.: National Conference of State Legislatures, 1992.
Eckl, Corina L. State Deficit Management Strategies. Denver, Colo.: National Conference of State Legislatures, 1987.
Fiscal Affairs Program. State Tax Actions. Denver, Colo.: National Conference of State Legislatures, various years.
Fiscal Affairs Program. State Budget Actions. Denver, Colo.: National Conference of State Legislatures, various years.
Hunzeker, Donna. "State Sentencing Systems and 'Truth in Sentencing.'" NCSL State Legislative Report 20, no. 3 (1995).
Hutchison, Tony. The Legislative Role in Revenue and Demographic Forecasting. Denver, Colo.: National Conference of State Legislatures, 1987.
King, Martha and Steve Christian. Medicaid Survival Kit. Denver, Colo.: National Conference of State Legislatures, 1996.
National Association of State Budget Officers. 1995 State Expenditure Report. Washington, D.C.: National Association of State Budget Officers, 1996.
National Governors' Association and National Association of State Budget Officers. The Fiscal Survey of States. Washington, D.C.: National Governors' Association and National Association of State Budget Officers, 1995.
NCSL Foundation Fiscal Partners. Fundamentals of Sound State Budgeting Practices. Denver, Colo.: National Conference of State Legislatures, 1995.
NCSL Foundation Fiscal Partners. Principles of a High-Quality State Revenue System. Denver, Colo.: National Conference of State Legislatures, 1995.
Pearson, Elizabeth, and Donna Lyons. "Privatization of State Corrections Management." NCSL LegisBrief 4, no. 6 (1996).
Pérez, Arturo, and Ronald Snell. Earmarking State Taxes. Denver, Colo.: National Conference of State Legislatures, 1995.
Rafool, Mandy. State Tax and Expenditure Limits. Denver, Colo.: National Conference of State Legislatures, 1996.
Snell, Ronald, ed. Financing State Government in the 1990s. Denver, Colo.: National Conference of State Legislatures and National Governors Association, 1993.
The Urban Institute, "Cutting Medicaid Spending in Response to Budget Caps," Washington, D.C.
U.S. Advisory Commission on Intergovernmental Relations. "RTS 1991: State Revenue Capacity and Effort." Washington, D.C.: ACIR (1993).

Written December 1996, posted January 2003, reviewed December 2003
Email statebudget-info@ncsl.org for more information.
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