State Budget Outlook Better but Not as Good as Before

Story appears in the 2013 Jan./Feb. issue of Capitol Ideas

When legislators return to their statehouses, the usual suspects of concern will be waiting for them—and some new areas that have been waiting in the wings will rear their heads as well.

States face looming fiscal problems in Medicaid, public pensions and budget gaps, as well as unemployment issues—both in the number of unemployed people who won’t receive benefits after federal extensions end and continued unemployment trust fund insolvency. That doesn’t even touch the problems of funding the everyday services constituents have come to expect.

“A lot of state budget officers are concerned that we will have growth, which is good, but over the next 10 years, the growth will be below normal,” said Scott Pattison, executive director of the National Association of State Budget Officers.

Current spending levels, he said, are about where states were in 2007 before the Great Recession. Most economists thought states’ pre-recession spending levels would return in 2014.

“We’re coming back to pre-recession spending about a year before we thought,” Pattison said.

While that’s good news, the total economic fallout from how the federal government deals with the fiscal cliff could impact states’ bottom lines in the year ahead. The cuts are a concern, Pattison said, but the overall hit to the economy would affect states even more.

State revenues always respond to economic cycles, said Rick Mattoon, senior economist and economic adviser for the Federal Reserve Bank of Chicago.

“As the economy is growing, revenues grow faster,” he said. “As the economy shrinks, revenues decline.”

But federal funding cuts eventually will come, and states must be prepared.

“The consensus is, outside of Medicaid, you’re going to see a lot of grant programs decline—that’s going to have an impact,” Pattison said.

Like the federal government, the biggest drivers of spending at the state level are related to health care. Medicaid spending has spiked in the last few years, although states have gotten it under control in the past year or so—a 3 percent increase versus previous growth of 13.5 percent.

That smaller increase is still a problem, Pattison said.

“You have a huge part of your budget growing faster than the amount of money you have coming in,” he said. “I’ve had budget directors say they’re thrilled that Medicaid slowed to a 4 percent growth, but their budget was growing at 2 percent so all their new money is still going to Medicaid.”

That will keep funding levels for every other program—except, possibly, K–12 education—flat, Pattison said.

States face another problem as Congress tries to address funding at the federal level.

“We’ve got this great big red bull’s-eye on us,” Barry Anderson, deputy director of the National Governors Association, said during The Council of State Governments’ 2012 National Conference.

That’s because of the top 10 tax breaks the federal government offers, two provisions that benefit states rank number two in cost. Those benefits—the deductibility of state and local income, sales and property taxes, as well as the exclusion of interest on public purpose state and local bonds—will likely be targeted by federal lawmakers.

Anderson said those provisions are unlikely to get preferential treatment over things like exclusion of employer payments for health insurance, which is the top tax break, or even deductibility of mortgage interest on owner-occupied homes, at number three, and deductibility of charitable contributions, at number eight.

NGA is stressing to Congress that states need to be at the table when changes to tax breaks are discussed. Anderson hopes Congress will consider these expenditures in the aggregate, not on an item-by-item basis when looking for deficit reduction.

“Don’t put balancing the budget on the backs of state and local governments,” Anderson said. “It’s a shared thing and we can help, but you (Congress) have to involve us in the process.”

Click here to look at four major fiscal issues states will be facing in 2013, as well as the top 5 issues in various policy areas.

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