Bridging the Ledger Divide: Fiscal Challenges across all 50 States

July 19, 2012
General Foundation

A new report by the State Budget Crisis Task Force describes the enormous fiscal challenges facing states all across the nation.  Their governments already spend $2.5 trillion a year and employ some 19 million people.  Unfortunately, the increasing spending obligations of states aren’t lining up with their expected revenue streams in the years ahead.  How this lengthening divide is bridged will have an enormous impact on the private sector as much as the public in the years ahead.  Here’s how the challenge looks on both sides of the ledger:

Expenses

  • Medicaid is rapidly growing in most states.  With Obamacare in place, costs are expected to grow by over 8% annually over the next 8 years.  Enrollments are higher than ever thanks to the recession and an aging population.  According to the report, “At recent rates of growth, state Medicaid costs will outstrip revenue growth by a wide margin, and the gap will continue to expand.”
  • State pensions are underfunded by upwards of $3 trillion.  Investment returns are low and states and localities have underpaid their contributions to pension funds by over $50 billion over the past 5 years.
  • Healthcare plans for state workers have over $600 billion in unfunded liabilities.  Moreover, “If the federal government increases the eligibility age for Medicare, thus lengthening the period during which retirees rely exclusively on state promises, [state healthcare] liabilities could increase still more.”

Revenue

  • Falling sales tax receipts are starting to take their toll.  The sales tax base has already declined by 37% over the past 40 years due to legislative changes and the rise of internet sales. Gas tax revenue, which is used to fund infrastructure development, is also declining as the tax rate is eroded by inflation.  The report notes that “between 1960 and 2010, state and local motor fuel taxes declined relative to the economy by 60%.” 
  • Income tax revenue is becoming increasingly volatile due to a dependence on the fates of the markets and those with high incomes.  New York, for example, saw its employment fall by a little over 4%, but incomes decline by 18% and capital gains by 75%. This is a worrying development for states like California, which garners 60% of its revenue from income tax receipts. 
  • Cuts in federal grants to states—which include monies for infrastructure investments, education, Medicaid, and more—are expected to be a key part of deficit reduction measures at the national level.  According to the report, “U.S. states depended on federal grants for 32% of their revenue in 2009.”  While we don’t know yet the extent to which federal funding to states will be cut, the report estimates that a 10% cut would lead to a loss of $60 billion annually for states.

 

States are facing a clear budget imbalance over the long term.  Compounding this challenge are a range of budgetary shell-games that some states employ in an attempt to balance their books, such as back-loading liabilities, capitalizing future revenue, moving agencies off the books, and selling assets off only to lease them back. Clear and consistent accounting together with more transparent institutions will go a long way toward helping states get a firm grip on their budgets.

Reforms are needed, yes, but economic growth is necessary to restore states to fiscal health.  NCF’s Enterprising States study found reasons to hope that many states are laying the foundation for a strong recovery from the depths of the recent recession.

“Huge increases in food exports, domestic energy investment, a revived manufacturing sector, a burgeoning tech sector, vital demographics, and increased investment from abroad create a strong base for long-term secular recovery of the U.S. economy. Rather than facing a dismal future of the new normal, we may actually be on the cusp of a recovery that could become one of America’s finest moments. The key to making this work, for the states and the nation, lies in policies that promote broad-based, long-term economic growth.”

The most enterprising states are governed on the basis of fiscal reality and market fundamentals. That, in the end, is the path to bridging the ledger divide.