State Strategies to Manage Budget Shortfalls

Front Matter
Chapter 1. Causes of Budget Shortfalls

Chapter 2. State Efforts to Manage Budget Shortfalls

Short-term or Stop-gap Measures
Cutting the Budget
Raising Revenues
Restrictions on Certain Deficit Reduction Actions

Chapter 3. State Methods to Avoid or Minimize Budget Shortfalls
Chapter 4. Options to Reduce State Spending in Major Program Areas
Chapter 5. State Expenditures That Cut Across Programs

2. State Efforts to Manage Budget Shortfalls

Because most states operate under a constitutional or statutory requirement for a balanced budget, they are required to resolve budget shortfalls and avoid potential deficits. Although their strategies vary, state officials usually:

Impose short-term or stop-gap measures;
Cut the budget;
Increase revenues; or
Implement some combination of these strategies.

Generally, the strategy depends on the following factors:

The amount of time remaining in the fiscal period. The timing of a shortfall within a budget cycle affects the choices that can be made to resolve it. When a shortfall occurs late in a fiscal period, there are fewer options to address it because many strategies do not produce immediate results.

The severity of the shortfall. Many strategies generate minimal revenues or produce modest budget savings. Although in combination they may add up to a sizable amount, they are unlikely to produce sufficient sums to resolve a severe budget shortfall.

Other actions that have been taken to eliminate recent shortfalls. In some cases, such as when the national economy is in a recession, states may experience multi-year shortfalls. Some strategies, such as revenue accelerations, may be unavailable if they were used recently and not yet reversed.

An important consideration is whether the strategies are seen as temporary or permanent solutions. If a state is experiencing a short-term budget problem, temporary, one-time measures may be sufficient to address it. If the problem is longer term or produces a structural deficit, permanent adjustments may be necessary. Many of the strategies reviewed in this chapter have been used as short-term or temporary solutions when states have encountered budget problems. A number of policymakers, however, have made these adjustments permanent in an effort to control and better manage their states' finances. Chapters 4 and 5 contain greater detail on more permanent strategies to address budget problems.

Table 1 illustrates the strategies states used to manage budget shortfalls occurring in FY 1993, a year in which budget problems were widespread among the states.

Short-term or Stop-gap Measures

Short-term or stop-gap strategies generally have an immediate effect on a budget shortfall. They are not intended to deal with fundamental budget problems. They may depend upon one-time savings or revenues, and they may seem like treating a serious infection with a pain reliever--an expedient, not a cure. For these reasons, such measures may be viewed as gimmicks.

But there are valid reasons for policymakers to use short-term measures:

State budget problems often result from the business cycle and may be short-term in nature. Overreaction can breed new problems.
Although short-term measures (deferred maintenance or postponed contributions to employee pension funds, for example) can themselves result in new problems, these usually can be corrected after the budget crisis has passed.

Carefully applied, short-term measures are a corrective to the cyclical nature of state budgeting--they smooth the curves of revenue and expenditures between recessions and recoveries. Balanced budget requirements and limits or prohibitions on short-term debt make it almost impossible for most states to avoid a cyclical fiscal policy. They have to balance their budgets in recessions, even though revenues fall and demand for spending increases. Both expenditure cuts and tax increases are damaging to a recessionary economy, so short-term strategies that avoid them can be effective remedies.

Examples of short-term or stop-gap measures include:

Delaying or eliminating capital expenditures and maintenance or shifting them from current funds to bond finance;
Delaying pay to state employees or payments to vendors;
Deferring tax refunds until the beginning of the next fiscal year;
Eliminating sales tax vendor compensation fees;
Reducing employee-related expenses, such as eliminating travel or imposing hiring freezes;
Shifting money to the general fund from funds that are not needed immediately or that have surpluses;
Tapping budget stabilization funds;
Accelerating tax collections; and
Postponing payments to or changing investment assumptions for state retirement systems.

Some short-term strategies would be irresponsible if they turned into permanent policies--delaying vendor payments, changing accounting methods, changing investment assumptions and tapping pension funds, for example. And some strategies produce one-time gains that have to be covered from some new revenue source in the future. Other strategies, such as tax accelerations, cannot be repeated unless they are reversed at some point (states often have reversed accelerations when prosperity returns). Delaying capital expenditures or maintenance can increase future expenditures. Bond underwriters may take a dim view of any such practices and downgrade bond ratings as a result.

Table 1. Strategies Used to Address Budget Problems Occurring in FY 1993
Temporary Measures (number of states)
Delayed payments to vendors (4)	District of Columbia, Maine, Montana, Texas
Postponed capital projects financed by the general fund (4)	Minnesota, Montana, Nevada, New Jersey
Replaced appropriations for capital projects with borrowing (5)	California, Maryland, Massachusetts, Missouri, Texas
Delayed equipment purchases (8)	California, District of Columbia, Kentucky, Louisiana, Massachusetts, Puerto Rico, Vermont, West Virginia
Other (2)	Michigan, New Jersey
Budget Reductions
Imposed across-the-board cuts (17)	Alabama, Connecticut, Idaho, Kansas, Kentucky, Maryland, Montana, North Dakota, Nebraska, New Jersey, New Mexico, Nevada, Ohio, Oklahoma, South Carolina, Vermont, West Virginia
Imposed selective cuts (19)	California, Colorado, District of Columbia, Florida, Georgia, Illinois, Louisiana, Maine, Maryland, Michigan, Minnesota, Montana, Nebraska, New Jersey, New York, Oregon, Puerto Rico, Texas, Washington
Eliminated programs (8)	Alaska, California, Illinois, Maryland, Nebraska, Oregon, Texas, Washington
Reduced aid to local governments (9)	Alaska, California, Illinois, Maine, Maryland, Michigan, Nebraska, Ohio, Vermont
Other (9)	California, Illinois, Indiana, Kentucky, Michigan, Minnesota, Missouri, New Jersey, Washington
State Employees
Implemented layoffs (10)	Alaska, District of Columbia, Illinois, Maryland, Minnesota, Nevada, New Jersey, Oklahoma, Oregon, Washington
Implemented furloughs (2)	District of Columbia, New Jersey
Imposed salary freeze (12)	Colorado, Georgia, Indiana, Maryland, Michigan, Minnesota, Missouri, New Jersey, Oklahoma, Oregon, Vermont, Washington
Eliminated vacant positions (12)	District of Columbia, Illinois, Louisiana, Maine, Maryland, Minnesota, Missouri, New Jersey, Nevada, Oklahoma, Oregon, Wyoming
Required employee contribution to fringe benefit costs (2)	California, Oregon
Reduced employer contribution to state pension fund (8)	Alaska, California, Indiana, Minnesota, New Jersey, Oregon, Vermont, Washington
Offered early retirement program (7)	California, Illinois, Michigan, Minnesota, New Jersey, Texas, Washington
Revenue Measures
Raised taxes (14)	Arkansas, California, Delaware, District of Columbia, Maryland, Massachusetts, Michigan, Montana, New York, New Mexico, Ohio, Oregon, Washington, Wyoming
Raised fees (17)	Arkansas, California, Delaware, District of Columbia, Maryland, Massachusetts, Minnesota, Montana, Nebraska, New Mexico, Nevada, New Jersey, Oklahoma, Oregon, Vermont, Washington, Wyoming
Accelerated tax collections (9)	Alabama, California, District of Columbia, Indiana, Montana, Nevada, New Jersey, Texas, Wyoming
Transferred funds to the general fund (19)	Alaska, Arkansas, California, Colorado, District of Columbia, Illinois, Kentucky, Louisiana, Maine, Maryland, Michigan, Montana, Nebraska, Nevada, New Jersey, Oklahoma, Texas, Vermont, Washington
Delayed transfers out of the general fund (4)	California, Colorado, Texas, Washington
Other (8)	Alabama, California, Illinois, Minnesota, New Jersey, New Mexico, New York, Oregon

These strategies may have other drawbacks as well. Anticipated savings or revenues can be substantially less than expected. There also has been a tendency to overestimate the value of these types of strategies in general, which leads to the inclusion of hidden deficits in a state's budget. As a result, legislators must be wary of the risks that accompany their budget strategies.

Cutting the Budget

As shown in table 2, cutting the budget is a common method used to eliminate a budget shortfall. The nature and extent of the reductions will vary depending on the size of the shortfall and whether other strategies, such as raising revenues, are used.

Cutting the budget to address a shortfall is an attractive option because the effect is immediate: the level of state spending is adjusted to fall within estimated available revenues by the end of the fiscal year. Depending on the size and scope of the cuts, the reductions can produce significant savings. There also may be political benefits if constituents perceive the government as holding the line on spending and avoiding tax increases.

Budget cuts provide policymakers with an opportunity to take a serious look at spending priorities. When revenues are plentiful, programs may continue without careful scrutiny. Reprioritization and reallocation are more likely to occur when revenues are scarce. Further, budget cuts may force agencies to rethink whether they are providing services in the most efficient manner.

Cutting the budget has drawbacks as well. Government services may be disrupted, and legislative priorities may be undermined. If the cuts come late in a fiscal year, agencies may have a difficult time implementing the cuts. And finally, the cuts likely will have more adverse effects on small agencies because larger agencies may have more ability to absorb the cuts.

In fact, there is a broad perception that government agencies can easily absorb some level of budget cuts. This may be true if an agency has, say, substantial salary savings or caseloads that do not materialize. Overall, however, budget cuts can be disruptive to the provision of services, especially if agencies have to absorb a series of small cuts year after year. In some instances, it may be preferable to make permanent funding and responsibility changes to save an agency from operating under constant budget uncertainty.

Table 2. States Cutting the Enacted Budget: FY 1989 - FY 1995
Fiscal Year	Number of States	Total Amount of Cuts ($ millions)	Percent of State Budgets
1989	13	$ 922.5	0.4%
1990	21	2,756.0	1.0
1991	29	7,558.4	2.6
1992	35	4,457.8	1.5
1993	22	1,836.4	0.6
1994	10	871.7	0.3
1995	8	442.4	0.1
Source: National Association of State Budget Officers, Fiscal Survey of the States, various years.

Before implementing cuts, some states have imposed budget set-asides or holdbacks--requirements that a certain proportion of agencies' appropriations cannot be spent without special approval. In FY 1996, for example, New Jersey's governor imposed an 8 percent holdback for all agencies except corrections expecting that some agencies would end up spending only 92 percent of their original appropriation. This would help the state out of a tight budget situation. Such holdbacks anticipate that revenues will be insufficient to cover appropriations so, as a precaution, agencies are required to operate at reduced spending levels.

With a severe budget shortfall, however, budget cuts are probable. To mitigate the adverse effects, policymakers often turn to selective cuts before imposing across-the-board cuts. Selective cuts have the advantage of preserving the budgets of high-priority agencies or programs while targeting lower priority or nonessential agencies for budget reductions. States usually try to protect funding for elementary-secondary education, Medicaid and corrections when budget cuts become necessary. Even when across-the-board cuts do become necessary, these areas may be exempt or subject to smaller cuts than other agencies or programs. When cutting budgets, policymakers also have eliminated programs, consolidated functions and eliminated certain boards and commissions.

Three budget areas that have seen sizable budget reductions when states have encountered budget problems are higher education, state employees and local government.

Higher education. Higher education funding has been a frequent casualty of state fiscal problems because it does not have the immediacy of public safety/corrections or the funding match requirements of Medicaid. It also has an alternative source of funding: tuition and fees. Higher education funding is discussed further in chapter 4.

State employees. Because employee salaries and benefits account for a significant portion of state budgets, state employees may be targeted when budget shortfalls are imminent. Permanently reducing the size of the state work force has the most potential to substantially reduce employee-related expenditures and is discussed further in chapter 5. Other methods states have used to reduce employee costs include eliminating vacant positions, offering early retirement programs, instituting furloughs, decreasing the state's contributions to employee benefits such as health care and pensions, freezing or reducing salaries, delaying salary increases, limiting or restricting hiring and allowing voluntary unpaid leave.

Local government. State aid to local governments, including aid for education, accounts for approximately 30 percent of total state spending. As a result, states often have targeted local aid for cuts when budget shortfalls have loomed. Despite the potential for large monetary savings, opponents of such action point out that reducing state aid merely shifts fiscal stress to local governments, unless the state provides some other assistance such as allowing local option taxes. Aid to local governments is discussed further in chapter 5.

Raising Revenues

Whether or not policymakers cut the budget, they may choose to raise revenues to deal with budget shortfalls. Revenues can be increased by freeing up existing revenues or by generating new ones. These increased revenues may be one-time in nature (e.g., revenue from tax amnesty programs) or long term (e.g., a permanent increase in the sales tax rate). Policymakers have raised revenues by:

Removing earmarking provisions from certain taxes;
Reducing tax allocations to local governments;
Authorizing tax amnesty programs;
Raising or imposing fees (e.g., environmental taxes and fees, license fees);
Increasing excise taxes (e.g., alcoholic beverage tax, cigarette tax, motor fuel tax);
Extending temporary taxes scheduled to expire;
Imposing health care provider taxes;
Broadening the bases of major taxes (e.g., personal income tax, sales and use tax);
Increasing tax rates (e.g., personal income tax, sales and use tax);
Implementing a new tax (e.g., tax on soft drinks); and
Issuing short-term or long-term debt (unavailable in most states).

As policymakers can attest, the choice of revenue-raising options is not as simple as picking from a menu, but must take into account political and economic considerations. For example: What are current tax rates and levels? How is the tax burden distributed between individuals and business? How would these tax increases affect the state's business climate and tax competitiveness? What kind of opposition will the tax generate? What federal provisions, if any, affect this tax? Will the action raise sufficient revenue to address the budget problem? The list is practically endless and raises many concerns. Further, as some opponents of tax increases point out, raising revenues to deal with budget problems assumes that states should continue to provide current levels of service. They note that this assumption should be evaluated, especially for longer-term budget problems. (To see the kinds of revenue-raising actions states have taken in the past decade, see NCSL's series of reports, State Tax Actions.)

Restrictions on Certain Deficit Reduction Actions

States may be limited in how they can respond to budget problems. Legal obligations and constitutional provisions may make some options unavailable. For example, collective bargaining agreements will limit budget reduction strategies affecting state employees. Constitutional restrictions against issuing short-term debt for ongoing operations make that option illegal for most states. But states also may be limited by practical considerations such as public sentiment and the need to provide a certain level of services. The antitax movement is strong in many states, so raising taxes may be a limited option in those states. And, finally citizens place a high priority on certain services, such as elementary-secondary education and public safety, so they would be strongly opposed to severe cuts in those areas.

Chapter 3. State Methods to Avoid or Minimize Budget Shortfalls