June 2003
By ROBERT PEGG
The weak economy, compounded by the events of 9/11 and a declining stock market, have severely strained state budgets for the foreseeable future. In most states, government financial conditions are worsening. With economic growth stagnant, tax revenues are faltering, and costs for health care Ð particularly Medicaid Ð are rising. New homeland security measures are placing added strains on local budgets to cover terrorism-related protection.
Most states across the nation have instituted rounds of belt-tightening actions to deal with their budget problems. However, many of these actions are one-time-only measures that may further exhaust options available to bring budgets back into balance and rendering decisions regarding future budgets more difficult.
Collectively, states are facing budget deficits in the range of $70 billion to $85 billion for state fiscal year 2004, which begins for most states on July 1, 2003. These deficits represent between 15 percent and 18 percent of all state expenditures. Unfortunately, these estimates are rising with every passing month. The current deficits are already on top of the large deficits many states had to close when they enacted their fiscal 2003 budgets. The 2004 deficits, collectively, are deeper than at any time in the last half-century. They are twice as sharp as those experienced in the early 1990s, for example.
Almost all the states have mandated balanced budget requirements, so that they must take actions to close these deficits. This situation is in contrast to the federal government, which normally runs deficits in the hundreds of billions and can borrow to cover the costs. State governments, on the other hand, are forced to use some combination of program cuts and revenue increases to close their budget gaps. The problem is that tax or fee increases represent disincentives for businesses and residents, while layoffs and program cutbacks usually hurt those who can least afford them. Given the large magnitude of the deficits, state actions are likely to cut basic services such as health care and education, as well as impose new tax burdens on low and middle-income families. Such actions are already occurring throughout many states in the nation, as state governments slash health insurance programs, cut deeply into budgets for elementary and secondary education and child care and force double-digit tuition increases at state colleges and universities.
New York State, New Jersey and Connecticut are among those states reporting very steep deficits. New York State is reporting a 2004 deficit of at least $10 billion, which is about 25 percent of the state's expense budget. Part of New York's strategy to close the gap may be to draw down or borrow from the tobacco settlement fundsÑthose resulting from court settlements over the past few years. States can securitize the tobacco settlement funds by issuing bonds backed by future tobacco settlement payments in exchange for cash up front. However, this strategy is short-term only and future expenditures will in time require a steady funding source or another revenue windfall. Increased debt service, substantial bond-broker commissions and fees and other tax implications may result from this strategy if implemented.
Other states are resorting to layoffs, furloughs, early retirement programs and hiring freezes. Still other states are resorting to increases in sales, personal income or corporate taxes. Other tax changes could include expanding the tax base on items that are currently exempt from taxation, such as building maintenance and golf lessons. Raising or expanding user fees for services such as vehicle registration and licensing or subscriber access to online services is yet another way to close budget deficits.
Perhaps the most effective way to close budget gaps is to overhaul functions addressing overlapping jurisdictions, management inefficiencies and costly administrative overhead. Pursuing budgetary, tax, fiscal and human resource policies aimed at improving public sector performance are the most desirable, but often the most difficult to attain and implement. Productivity improvements linked to service efficiencies often have been seen by state administrations as the best way to go.
Ultimately, the state budgets will be balanced and programs eventually restored. State fiscal conditions usually continue to deteriorate after an economic recovery has begun. State fiscal recovery typically lags national economic recovery by 12 to 18 months. In 1991, for example, the nation was in a period of economic recovery, yet state deficits were larger in 1992 than in 1991. In the current recovery, however, it is still unclear when to consider the 12 to 18 month clock as beginning to run, since economic conditions and job growth have continued to be erratic.
About the author: Mr. Pegg is president of Kirkbride Asset Management, the New York City-based investment advisory firm which serves businesses, institutions and private individuals.