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State Strategies to Manage Budget ShortfallsContents
4. Options to Reduce State Spending in Major Program AreasChapter 3 reviews strategies states have used to address short-term budget shortfalls. Not all budget shortfalls, however, are due to unanticipated, short-term factors like court decisions, recessions or inaccurate revenue estimates. Some states face perennial budget shortfalls when the rate of growth of major expenditure programs exceeds the rate of growth of revenues necessary to fund them. This type of imbalance is commonly called a "structural deficit." Short-term measures like those described in chapter 3 may help states temporarily avoid shortfalls, but generally they are ill-suited to address structural deficits. This chapter identifies the major spending categories in state budgets. It discusses state strategies to reduce spending growth in these programs and provides several short case studies that illustrate these strategies and discuss their effectiveness. The other factor contributing to structural deficits--the nature of state revenue systems--is addressed in NCSL's publication Financing State Government in the 1990s. Figure 2. Components of State General Fund Spending, FY 1995
Source: National Association of State Budget Officers, 1995 State Expenditure Report, April 1996. Key Sources of State SpendingFigure 2 provides a breakdown of the major functional categories of state spending in fiscal year (FY) 1995. The five largest functional categories of state general fund spending are elementary-secondary (K-12) education, Medicaid, higher education, corrections, and Aid to Families with Dependent Children (AFDC) and welfare. In combination, these programs received more than 70 percent of general fund expenditures in FY 1995. With the exception of AFDC, the share of state spending on these programs has been slowly growing for years. All other programs--including general purpose local aid, environmental protection, economic development, employment and training and many others--made up the remaining 28 percent of general fund spending. This chapter focuses on reducing expenditures in the five general fund programs listed above. K-12 EducationOver the last 25 years, states have significantly increased their commitment to funding K-12 education. State funding has grown in real terms as a result of legislative efforts to improve the quality of education, growth in student enrollment in some states, court decisions requiring states to equalize spending between poor and rich districts, the increased cost of federally mandated special education programs and legislative or citizen initiatives to reduce the local property tax burden. K-12 education represented 33.8 percent of state general fund spending in FY 1995 (figure 2). As noted in chapter 2, states usually try to preserve funding for K-12 education when shortfalls occur. Nevertheless, there are several options for reducing school funding, including across-the-board cuts in general state aid programs, reducing the foundation funding amount, reducing or eliminating minimum aid amounts or reducing categorical aid programs for such items as transportation, special education and capital outlay. Across-the-board cuts. Across-the-board cuts are sometimes used to address midyear budget shortfalls. They provide immediate and certain savings to the state budget because aid disbursement amounts are under the direct control of the state. Across-the-board cuts treat all school districts that receive state aid equally and generally do not undermine the redistributive effects of school finance formulas. However, school districts have little flexibility to reduce planned expenditures during a fiscal year because personnel costs are a large proportion of school spending. Reducing the foundation amount. Forty of the 50 states use a foundation school aid formula. {For more information, see Steven D. Gold, et al, "Public School Finance Programs in the U.S. and Canada, 1993-94" (Albany, N.Y.: Center for the Study of the States, 1995).} The foundation amount--set by the legislature--is the amount of per pupil funding that is required to provide a minimum level of educational services. The state provides local districts with the difference between the foundation amount and the amount of local funds that can be raised with a local property tax rate determined by the legislature. Reducing the foundation amount reduces the amount of per pupil state aid required under the formula. It may also increase the number of districts that do not receive state aid because they can raise more than the foundation amount through their own local property tax base. Relatively small reductions in the foundation amount can create significant savings in state education spending. They also ensure that the bulk of state formula aid continues to flow to the poorest districts. However, reductions in foundation support may increase property taxes for taxpayers in districts that receive little or no state aid, eroding political support for state aid from legislators in those districts. Also, reducing the foundation amount may harm efforts to equalize spending between rich and poor districts by reducing per pupil spending in poor districts. Case Study: K-12 Foundation Aid Reductions in Vermont Reducing or eliminating minimum aid amounts. Some states provide minimum aid amounts to all school districts regardless of their fiscal capacity. The rationale for minimum aid is to ensure that all taxpayers who pay general fund taxes to support public education, even those in wealthy communities, receive some state educational support. Minimum aid formulas help build political support for school finance bills in the legislature, so eliminating minimum aid amounts may make consensus-building more difficult. However, reducing or eliminating minimum aid would ensure that reductions are targeted to those districts that can most afford to absorb them through additional local tax effort. Reducing categorical aid. Categorical aid programs provide state aid for specific purposes such as transportation, teacher retirement, special education or capital construction. In most states, even the wealthiest school districts receive aid for these items. Proponents argue that categorical aid programs are designed to reflect special factors, such as high transportation costs in rural areas or high costs imposed by federal special education mandates. Reducing categorical aid, particularly as an alternative to cuts in the general state aid program, would help protect most of the poorest school districts from aid reductions. However, reductions in categorical aid programs could disproportionately harm rural areas that receive transportation aid or small districts with a higher percentage of special needs students. This is particularly burdensome because by law schools cannot reduce services to those students. MedicaidMedicaid is a joint state-federal program that provides medical care for the poor and medical and institutional care for the eligible elderly and disabled. During the last five years, the growth rate of the Medicaid program has been higher than any other major area of state general fund budgets. Although individual states' experiences varied widely, nationally, Medicaid's share of state budgets grew from less than 10 percent in FY 1989 to 14.3 percent in FY 1995. States spent almost $59 billion on the Medicaid program in FY 1995. {National Association of State Budget Officers, 1995 State Expenditure Report, p. 93.} Federal rules limit states' ability to reduce Medicaid in several ways. First, because the federal government reimburses state expenditures at rates between 50 percent and 80 percent, state actions that reduce Medicaid spending return only a fraction of the savings to the state budget. Second, federal rules require that states participating in Medicaid cover certain low-income, disabled and elderly populations. States that attempt to reduce or eliminate benefits to these individuals will be sued in federal court. Third, Medicaid rules limit states' ability to move beneficiaries into managed care. Although waivers are available, the waiver process can be time-consuming, and there is no guarantee of approval. Fourth, a federal law known as the Boren amendment limits options for reducing payments to providers because it requires states to make reasonable reimbursements to cover provider costs. Finally, states that have expanded coverage beyond federal minimum requirements may be subject to maintenance-of-effort requirements if they try later to eliminate optional groups. In 1996, Congress approved proposals to loosen many restrictions on states' Medicaid programs. Although these proposals were vetoed by the president, it is possible that states--either through law changes or waivers--may have additional options to reduce Medicaid program costs in the coming years. The following discussion outlines options for states if existing restrictions are removed or if federal waivers are adopted that allow more state flexibility in the program. It is summarized from a 1995 report by the Urban Institute, "Cutting Medicaid Spending in Response to Budget Caps." Medicaid is really two programs: an acute care program for eligible elderly, disabled and low-income Americans and a long-term care program for the eligible elderly and disabled. The first four options below relate to the acute care portion of Medicaid, and the subsequent four discuss potential savings in the long-term care portion. The last option discusses provider taxes. Managed care. One option to reduce program costs is to move Medicaid recipients into managed care health plans, such as health maintenance organizations (HMOs). Almost every state has some type of Medicaid managed care plan. Many states have placed former AFDC-eligible beneficiaries and the expanded populations of children and pregnant women in managed care. Managed care plans require patients to see only physicians who are part of a plan's network. All patient services are coordinated through a primary care physician. In the 1990s, private sector businesses contracting with managed care plans have enjoyed significant savings over fee-for-service plans in many markets. However, because Medicaid provider payment rates are typically lower than private sector plans, the margin of savings for states is smaller than in the private sector. Also, it is not certain moving the most expensive Medicaid beneficiaries--people with disabilities and the elderly--into managed care plans will result in similar cost savings. Case Study: Arizona's Managed Care Program Provider payment reductions. Another cost-saving option is to reduce payments to physicians, hospitals and other providers that treat Medicaid patients. Market conditions (the need to reimburse providers adequately) and the federal Boren amendment (which requires that state reimbursements cover reasonable provider costs) limit states' freedom to act in this area. Nonetheless, reductions in provider rates have been a common strategy to control Medicaid costs. In FY 1994, 12 states cut provider rates for certain services, and five others froze them at current levels. Nursing homes and home health care providers were particularly likely to be targets of these practices. In 1995, nine additional states imposed reductions in reimbursements on health providers. Such reductions may raise concerns about the maintenance of quality care. Details on state policy on provider payments appear in NCSL's Medicaid Survival Kit, designed to help legislators understand existing Medicaid policies. {Martha King and Steve Christian, Medicaid Survival Kit (Denver: NCSL, 1996} Case Study: Provider Reimbursement Reductions in West Virginia Higher EducationWhen states have encountered fiscal problems, they have often reduced state appropriations for higher education. Over the last five years, higher education budgets have been cut, experienced little or no growth or have grown at less than the rate of inflation. As a result, higher education funding has shrunk as a share of state general fund spending. Although higher education funding rebounded somewhat in FY 1996, it represented only 13 percent of general fund spending, below the 15.4 percent it represented in FY 1988.Typically, the budget for state higher education is set by maintaining a base amount and adding allowances for enrollment and salary increases. In tough economic times, like during the national recession of the early 1990s, the base budgets for higher education and enhancements are subject to reductions. In most states, the base budget is not increased automatically to serve additional students. This places higher education at a disadvantage in the competition for state support and contributes to the lack of funding stability. Officials at many higher education institutions have responded to budget cuts by raising tuition and fees, which often requires legislative approval. Since 1990, tuition and fees at public four-year institutions have increased nationally by 56 percent. Tuition and fees often increase every year, but the rate of increase typically is faster when states are in the midst of budget problems. For example, tuition and fees at four-year public colleges increased an average of 7 percent annually in the 1989-90 and 1990-91 school years. But in the next two years, the rate of increase hit double digits, 12 percent and 10 percent, respectively. By the 1994-95 school year, the rate had dropped to 6 percent. Other responses to reduced state support include very small or no increases in pay for faculty, capping enrollment growth, dropping academic programs and increasing class sizes. Some states, like Arizona, are making greater use of “distance learning” through the use of telecommunication networks, which has helped avoid capital outlay costs. The effects of reduced state support for higher education have been similar in many states. For example, tuition and fees in Oregon have grown by 65 percent over the last five years. and enrollment dropped from 64,900 in 1989 to an estimated 60,000 in 1995. Officials report that the drop in enrollment is tied to increases in tuition and fees. At the same time enrollment has declined, Oregon has seen students shift to community colleges where tuition and fees have not risen as much as at the four-year institutions. Arizona actually is doing more to promote “2 + 2” learning-where students spend their first two years at a less expensive community college and the second two years at a joint facility operated by both a community college and a university. In California, state financial support for the four-year college system dropped 6.6 percent between 1990 and 1995. This decrease contributed to tuition and fee increases of 130 percent since 1990, sharply driving up the costs of public higher education and contributing to an enrollment decline of 7 percent-more than 30,000 students in the last five years. This drop in student enrollment marked the first time in California’s history that there was not an increase in college enrollment during an economic recession. Other causes of the drop in enrollment were fewer course sections available and fewer outreach and recruitment programs. Higher education officials deliberately cut enrollment in the early 1990s as they pursued a policy of accepting only as many students as the state budget funded. But even with a new policy of recruiting students aggressively and a one-year moratorium on tuition and fee increases imposed in the FY 1996 budget, campuses have failed to attract enough students to meet the legislature’s target for the year. In many cases, states only now are evaluating the effects that their recent budget decisions have had on higher education. The different funding environment that exists for higher education calls for some creative thinking and problem-solving if states are going to provide a quality education in an affordable manner. Case Study: Higher Education Funding in Washington Case Study: Higher Education Funding in Virginia CorrectionsCorrections expenditures represent a rapidly growing area of state budgets and show no sign of slowing. In 1986, state corrections spending for adult prisoners (excluding capital costs) was about $7 billion. By 1996, corrections spending increased to $20 billion and now accounts for almost 6 percent of state general fund expenditures. {National Conference of State Legislatures, State Budget Actions (Denver: NCSL, various years).} Growth in corrections spending is being driven by several factors:
This section explores several policy options designed to reduce state corrections costs. It discusses privatization, community corrections and mechanisms to control the size of inmate populations. Privatization. The number of privately operated state correctional facilities in the United States has increased from zero in 1983 to more than 80 in 1995, although they remain a small portion of the total facilities in the United States.{Elizabeth Pearson and Donna Lyons, "Privatization of State Corrections Management," NCSL LegisBrief, 4, no. 6, Jan. 1996.} Contracting for the construction and operation of private facilities allows states to avoid up-front capital construction costs and may provide operational savings as well. Proponents also cite the benefits of competition in keeping state facility costs down and the financial benefit for state and local governments of having taxable instead of tax-exempt facilities. Privatization in the correctional system can range from small operations such as food service and health care to the entire operation of a prison. Opponents of prison privatization cite lower wages and benefits that could reduce living standards for correctional employees, the concern that lack of competition will eventually allow private companies to enjoy monopoly pricing power and the compromising of food service and medical care in order to control costs. There is also the concern that even under a private contract, the state remains responsible for any problems that may occur. Although half the states allow private management of correctional facilities, few have conducted comprehensive evaluations of private facilities versus public facilities. In the states where evaluations have been conducted, the results are somewhat mixed, as the examples from Tennessee and Texas demonstrate. Case Study: Privatization in Tennessee and Texas Community corrections. Community corrections is the term given to those sanctions that punish an offender within his or her own community, typically falling between traditional probation and a prison sentence. The most commonly used community corrections programs are intensive supervised probation, day reporting centers, house arrest and electronic monitoring, restitution, community service and fines. According to several studies, community corrections programs can be four to five times less expensive than incarceration. For example, a 1987 study by the Rand Corporation found that the annual cost for intensive probation ranged from $1,500 to $7,000 while annual costs to be housed in a state prison ranged from $9,000 to $20,000. Annual costs for other community corrections programs fell between these amounts. {Joan Petersilia, Expanding Options for Criminal Sentencing, (The Rand Corporation, 1987): 83.} Community corrections have the potential to reduce state correctional system costs if convicted offenders are sentenced to intermediate punishments instead of prison. When integrated into the menu of sentencing options available to judges, community corrections programs can help states avoid the need for new prison beds. However, if community corrections sanctions supplement prison sentences instead of supplanting them, these programs can actually increase system costs in both the short term and the long term. Further, if the courts are not selective in choosing candidates for community corrections, offenders in community corrections programs may commit new crimes and end up in prison, increasing overall system costs. Community corrections programs, used properly, can alleviate prison overcrowding and help ensure that the most violent offenders serve a longer portion of their sentences because prison space is available to house them. In some states, these programs have reduced recidivism rates for defendants awaiting trial. The downside to community corrections programs is that public confidence can be eroded by highly publicized failures that are inevitable in all sentencing alternatives. Community corrections programs cannot provide overnight savings. It takes states several years to create a community corrections infrastructure, educate court officers about the system and allow judges time to develop confidence in the system. States have found that diverting a portion of the correctional system's operating budget into community corrections--rather than providing new, additional funding for the program--can help ensure that community corrections supplant prison sentences instead of supplementing them. Case Study: Community Corrections in Connecticut Controlling the size of the inmate population. As previously noted, the burgeoning prison population is an important factor in explaining the growth of state corrections budgets. More inmates mean more prisons. Although building new prisons requires sizable up-front expenditures, many states issue bonds to cover the expense. More problematic for state budgets are the ongoing costs to operate prisons: Two-thirds of corrections budgets are used to operate, maintain and staff prisons. {Jill Ross Schmelz, "Analyzing the Growth of State-Local Corrections Spending" (Albany, N.Y.: The Nelson A. Rockefeller Institute of Government, July 1995): 7.} In addition to housing more prisoners, states also are faced with growing incarceration costs. For example, the Bureau of Justice Statistics reported that the average per-inmate cost in 1984 was $11,302. But by 1990, the latest year for which comprehensive data are available, the average cost had grown to $15,513. {Discussion with staff at the Bureau of Justice Statistics Clearinghouse, July 10, 1996. Recognizing that managing the number of inmates is key to managing corrections costs, some states have taken steps to control the size of the inmate population. Sentencing reform in the states often has included mandatory minimum and other sentence enhancements that increase prison populations. Sentencing guidelines, or "structured sentencing," have sought to create a more manageable system that balances sentencing policy with available resources. Sentencing guidelines generally have been developed by a commission created and overseen by the legislature. The commission has the ongoing responsibility for monitoring and measuring changes in sentencing policy and the effect on correctional resource needs. Structured sentencing typically uses a matrix or grid format that plots the severity of the crime with prior criminal history to determine the sentence to be imposed. Guidelines systems can, in a uniform and predictable manner, build in shorter and alternative prison sentences for less serious crimes and offenders and reserve finite prison space and resources for the most habitual and dangerous offenders. By 1995 legislatures in 16 states had approved and implemented some form of sentencing guidelines. (For more information see, Hunzeker, "State Sentencing Systems and 'Truth in Sentencing.'") Case Study: Structured Sentencing in North Carolina TANF/WelfareState expenditures for family assistance--formerly the Aid to Families with Dependent Children (AFDC) program and now the Temporary Assistance to Needy Families (TANF) program--and other welfare programs (primarily SSI supplements and general assistance) are about 4.6 percent of the general fund budget. Therefore, welfare spending reductions will not significantly affect state budgets. The primary state welfare program is the state-federal TANF program. (States must transfer from AFDC to TANF by July 1, 1997, which most states already have done.) TANF re-structures federal financing for family assistance. Rather than the federal government matching state welfare spending as they did in AFDC, states receive a set amount of funding--the block grant. The block grant does not change automatically when a state's assistance spending increases or decreases. States also have considerable new flexibility to revise their welfare programs to reduce spending, including changing benefit levels and eligibility requirements. The TANF program limits states' financial flexibility in three important ways. First, federal legislation requires that states achieve work participation requirements that increase over time. Minimum participation starts at 25 percent of all adults working at least 20 hours a week in FY 1997. It increases gradually to 50 percent of all adults working 30 hours a week by FY 2002. Failure to meet these requirements will result in a penalty of 5 percent of the state's block grant. The penalty increases by 2 percent each year the state continues to fail to meet the participation requirements, up to a maximum of 21 percent. Second, the maintenance of effort requirement limits how far states can reduce their own spending without losing federal funds--80 percent of their FY 1994 spending levels initially and 75 percent of those levels for those states that meet the work participation rate requirements. Reductions below these levels would result in a dollar-for-dollar reduction in the federal block grant. Third, the legislation establishes a contingency fund that provides additional federal funding for states during serious economic downturns. Access to this fund is triggered by increases in the state's unemployment rate or food stamp enrollment. This fund provides states with some protection against a recession, but restricts how states can reduce their own spending. To get money from the contingency fund requires a state to spend at the 100 percent maintenance of effort level. Any additional state spending would be matched at the Medicaid rate. The block grant system shifts the financial risk of welfare programs to the states. Reductions in family assistance spending will go back completely to the state. At the same time, increases in spending will come out of state funds. And states must be concerned with meeting their work participation rates and getting families into work so that they can support themselves. This increases the stakes of states' efforts to reduce welfare spending as well as the importance of their decisions about investing funds in welfare-to-work programs. Reduce or eliminate non-AFDC welfare programs. In 1995, 42 states had some type of general assistance program that provides nonfederal cash assistance for persons not eligible for AFDC or SSI. Typically, cash assistance is provided to single adult males who do not work or have exhausted unemployment benefits. General assistance is usually the last safety net program available to this segment of the poor population. (Disabled citizens who are unable to work typically qualify for Social Security or SSI.) Unlike the AFDC program, general assistance programs do not receive matching federal dollars. Therefore, eliminating or reducing general assistance does not trigger federal penalties or a loss of federal matching money. Case Study: Welfare Reform in Michigan in 1991-92 Reduce TANF benefit levels. Under TANF, states are no longer restricted in how much they can reduce benefit levels. Cash benefit levels for poor families have not kept pace with inflation during the last decade. Although some of this loss in purchasing power has been offset by increases in federal food stamp benefits, poor families have already experienced a decline in benefits when adjusted for inflation. Cuts will impose further hardships on poor TANF recipients for limited budget savings. Change eligibility levels. States have discretion to change eligibility levels for TANF. These are the income, asset, poverty and household size factors that states use to determine eligibility for benefits. In recent years, states have tried to reduce costs by imposing a family cap that denies additional benefits for additional children, requiring teen parents to live with their families, changing the definition of poverty or imposing work or training requirements on beneficiaries. Most of these changes have occurred in the mid-1990s so there are few data on whether they have reduced state expenditures. However, most experts do not expect significant savings from these eligibility changes, particularly savings large enough to offset the increased administrative costs of imposing the new requirements. Reduce administrative costs. A sizable share of the cost of welfare programs is administration. Administrative costs come out of the TANF block grant so reducing these costs saves state money. Alternatives for reducing administrative costs include improving computer systems, reducing complex eligibility requirements, using electronic funds transfer (EFT), increasing per worker caseloads and developing one-stop shopping centers that would combine other state and federal benefit program administration in one location. Some of these strategies--such as improved computerization and EFT--may require an up-front investment to achieve productivity savings. Others, such as increasing caseloads per worker, run counter to recent welfare reform efforts that seek to impose work activity requirements on recipients. For these reasons, administrative cost reduction holds limited promise for reducing program expenditures. Chapter 5. State Expenditures That Cut Across Programs Written December 1996, posted January 2003, reviewed December 2003 |
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