A Foggy Fiscal Future: February 2012

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State budget forecasts call for clearing skies in the new year, but no one is breaking out the champagne just yet.

By Edward P. Smith

With four years of a brutal economy behind them and a rising tide of revenues, you might think state lawmakers would be breathing a sigh of relief as they work on their fiscal year 2013 budgets.

But they’re not.

Instead, the worst recession since the 1930s has given way to something else—call it the Great Uncertainty—that has left lawmakers playing a guessing game about what money they can expect from the federal government, fearful about the economic ripples from the debt crisis in Europe, and frustrated by a stubbornly high unemployment rate that was in the double digits in eight states as of November.

Legislative budget officials are concerned “about the fragility of the economic recovery,” says Arturo Pérez, director of the fiscal program at the National Conference of State Legislatures.

“How Congress will address the national deficit and the impact that will have on state budgets adds to the uncertainty,” he says. “The ongoing European debt crisis has created additional turmoil in the financial markets and shaken investor confidence. An overriding concern among legislative budget officials is that harmful economic developments could stall recent improvements in state budgets, resulting in a decline in finances.”

Now the good news. For the first time in four years, lawmakers will not be spending the early part of their legislative sessions addressing current budget shortfalls. The cumulative new budget gap for FY 2012 as of November was $4.4 billion, compared with $26.7 billion for FY 2011 in November 2010.

Year-end balances—the combined amount of closing general fund and rainy day fund balances—are a key indicator of state fiscal health. State officials expect to end FY 2012 with reserves equal to 5.5 percent of general fund appropriations, which Pérez says is an indication that those accounts are stabilizing.

For its latest “State Budget Update,” NCSL surveyed legislative fiscal officers and found “the deterioration that dominated state finances in recent years has eased.” Revenues are increasing, expenditures are stable in most states and newly opened budget gaps are rare.

“The revenue growth states have experienced has helped to mitigate budget shortfalls,” says William Pound, executive director of NCSL. “It could help stave off some of the deep cuts lawmakers have made in previous sessions.”

Despite these developments, “the effects of the Great Recession continue to linger,” the reports states. The current fiscal year marks the fourth consecutive year states have faced a significant mismatch between revenue and spending. During that period, states have faced cumulative budget gaps of more than $500 billion. Three of the nation’s largest states—California, Florida and New York—all saw revenues fall short of projections only a few months into FY 2012.

Add to still weak revenues a higher demand for state services, especially Medicaid, a rising poverty rate, a continuing problem with foreclosures and a national unemployment rate of 8.6 percent.

It’s only reasonable to expect the recovery to come slowly, says Beth Ann Bovino, deputy chief economist for Standard & Poor’s. 

“We went through one of the worst financial crises since World War II,” she says. “We’re going to see many years of subpar growth” that is largely tied to households, businesses and the government shedding debt.

By the Numbers

$514.9 billion
Total cumulative budget gaps closed by states from FY 2009-FY 2013

Average amount of state general funds spent on Medicaid for FY 2010

Average amount of state general funds spent on K-12 education for FY 2010

Average amount of state general funds spent on higher education for FY 2010

Source: NCSL, National Association of State Budget Officers. 

Recession Lingers

Most states expect revenue to meet or exceed estimates in FY 2012, according to NCSL’s latest report.

Seventeen states reported collections of personal income taxes exceeded estimates, and 16 said their collections were on target. Collections are falling short of estimates in nine states and Puerto Rico. Seven states have no personal income tax and two tax only income from interest and dividends.

General sales tax revenues also are stronger, with 18 states reporting collections higher than estimated, 17 states and Puerto Rico on target, and 10 states under estimates. Five states do not tax retail sales.

Corporate incomes taxes, which amount to only about 5 percent of all state revenue in those states that collect them, also are relatively strong, with 37 states reporting collections either at or above projections. Six states do not levy a corporate income tax. 

When legislative fiscal directors were asked about their overall outlook for the remainder of FY 2012, most sounded more upbeat than they have in years. In seven states, officials were “positive” about the future. In 23 states, they were “cautiously optimistic,” and in 20 others they were “concerned,” a bit more downbeat assessment. None, however, said they were “pessimistic” about the outlook for the remainder of the fiscal year.

Stubborn Unemployment

Unemployment continues to be the anchor weighing down the U.S. economy, and no one projects a spurt in job growth.

“There is no V-shaped recovery in the works,” says Bovino. “The unemployment rate will likely stay high. I’m not expecting something below 8 percent for the next few years.”

She notes that 9 million jobs were lost during the recession (December 2007 through June 2009), and 2 million have been added since.

In states especially hard-hit by the housing crisis—California, Florida and Nevada—the jobs situation in construction is especially grim.

Construction unemployment is in the double digits in those states, says Bovino. “Among people without a high school education, the unemployment rate is more than 14 percent.”

Nevada Assemblywoman Debbie Smith, chair of the Ways and Means Committee and speaker pro tem, says that with the highest unemployment rate in the nation—13.4 percent—the jobs picture in her state is not likely to improve soon.

“I think the projections are that we’ll have a long, slow climb” out of high unemployment, she says. “As the fastest growing state for more than 20 years, you can imagine how many of our residents were employed in the construction industry. That unemployment rate is difficult to mitigate.”

Smith sees signs, however, that Nevada’s economy is starting to recover.

“Our state is heavily dependent on tourism, and those numbers are coming back,” she says. “Convention bookings are looking really good, which is great news. The cab industry in Las Vegas, for example, just experienced its biggest month ever at the airport, with more than 300,000 cabs picking up passengers. That’s really good news.”

Public sector job losses also are a drag on the economy. While job creation in the private sector perked up in the last half of 2011, state and local governments have shed about 650,000 jobs since 2008.
Michigan public employees took an especially hard hit, according to Senator Roger Kahn, chair of the Appropriations Committee. He points out the state saw a net increase of 94,500 jobs since employment bottomed out in December 2009, but in the same period the public sector cut 25,400 jobs.

“Job losses in the public sector in Michigan since the ‘recovery’ started have lowered the gain in employment by more than 21 percent,” Kahn says. And the University of Michigan has forecast even more government job losses this year.

Alabama Senator Arthur Orr, who chairs the Finance and Taxation General Fund Committee, says state government is “just beginning layoffs but more are likely in the future.”

“We’ve had a hiring and pay freeze in effect for several years now. If anything, it’s morale that is suffering right now among state employees and public educators in Alabama.”

Setting Fiscal Priorities

NCSL asked legislative fiscal directors to identify the top three fiscal issues lawmakers in their states will address in the 2012 legislative sessions.

Numerous uncertainties pose a challenge to state fiscal recovery, so it’s not surprising that, yet again, the budget is anticipated to top legislative agendas in nearly half of the states. Concerns about Medicaid, pensions, education, revenues and transportation also loom large.

  • Addressing the budget will be the top fiscal priority in 2012 sessions. Concerns about structural gaps, spending pressures, budget reductions and the absence of one-time funds are expected to capture the most attention.
  • Medicaid and health care costs are a particular concern. Issues to be addressed include the growth in enrollment and use of the program; reduction in the amount the federal government pays for the program; and implementation of federal health reform.
  • Pensions, retirement systems and other state employee issues also will receive significant attention. Addressing unfunded liabilities, increasing employee contributions and enacting major reforms may lie in the year ahead for state lawmakers.
  • Education will be another top fiscal priority. Discussions will center on adequate funding levels, school finance formulas and increased student enrollment.
  • Other top fiscal issues include state taxes and revenues, transportation and other infrastructure projects, uncertainties surrounding federal deficit reduction and efforts to spark job creation.

Although positive revenue developments have helped ease some pressure on state budgets, significant challenges await lawmakers in 2012 legislative sessions.

—Todd Haggerty, NCSL. 

Struggling With Medicaid

A bad economy with millions of people out of work inevitably puts pressure on safety net programs, particularly Medicaid. Compared to any other social program, it’s the one that sucks all the air—and money—out of the room.

The state-federal program costs nearly $400 billion a year, more than 15 cents out of every state general fund dollar. Although the program often is seen as health care for the poor, nearly 67 percent of all Medicaid spending goes to care for the severely disabled and the elderly who need long-term care. Enrollment varies as people move in and out of the program, but in the past three years has risen from an average of about 54 million to about 60 million.

Lawmakers are concerned about the impact on Medicaid when provisions of federal health reform go into effect in 2014. The cost of the program is expected to increase to about $840 billion by FY 2019 and average enrollment is expected to reach 78 million, according to the Centers for Medicare & Medicaid Services.

States are trying a variety of approaches to control costs, but that’s tough, given the program growth and the loss of federal stimulus funds that helped pay for Medicaid through FY 2011.

“Medicaid spending was the fastest growing program in FY 2012 budgets” in at least 34 states, Pérez says. “Most of the growth was attributed to ‘back filling’ for lost federal stimulus funds.”

Smith says her state also has seen a spike in Medicaid enrollees, which is not surprising, given Nevada’s unemployment rate.

“Our cost per eligible person is actually down some, but the enrollment numbers continue to rise,” Smith says. “They aren’t going up as fast as they were two years ago, at the peak of the recession, but it’s still climbing. I wouldn’t expect we’ll see any relief this year.”

Medicaid benefits vary by state, although all must offer a basic level. Even in those states that provide the fewest services, there is plenty of fiscal pain.

“Though Alabama has close to a minimum level of services in its Medicaid system, we still see significant increases in costs due to additional enrollees and, to a lesser extent, medical costs,” says Orr, who expects Medicaid expenditures to continue growing during the economic downtown. “Without more flexibility from the federal government, we will continue to be restricted in our options and, consequently, cost containment strategies.”

It’s not only states such as Alabama and Nevada that are finding Medicaid a larger burden. Wyoming, with an unemployment rate below 6 percent and more solid fiscal footing than many states, also has challenges.

“Medicaid is a significant burden in our state. The cost generally runs about 15 percent to 20 percent of the general fund,” says Wyoming Representative Rosie Berger, who chairs the House Appropriations Committee. “Recipients have gone up in number, and costs per individual continue to rise.

And she sees “no indication yet that the burden is easing. I hope we can manage the unknown. This is one of the reasons that we continue to build our reserve account, to be capable of managing the unexpected in 2013.”

Edward P. Smith is the managing editor of State Legislatures.