State Budgets in 2009 and 2010

Fiscal conditions rapidly deteriorated for states in the 2009 fiscal year as the nation remained in a prolonged economic downturn. States experienced unprecedented declines in both revenues and state spending, while rainy day fund levels sharply declined from the 2008 fiscal year. While the national economy may be slowly recovering, conditions have not improved for states in the 2010 fiscal year. State spending is projected to be negative for the second year in a row. Revenue collections remain weak, with total collections declining for a record five consecutive quarters. The state fiscal outlook is expected to remain grim in fiscal 2011 and beyond as Recovery Act funds decrease and revenues are slow to recover.

Book of the States 2010, Chapter 7: State Finance

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Introduction

The deterioration of state finances that began in the 2008 fiscal year rapidly worsened in the 2009 fiscal year. Revenues, state spending and rainy day fund levels all declined sharply, according to the National Association of State Budget Officers, commonly known as NASBO. While the 2008 fiscal year saw modest revenue growth of 2.2 percent, revenue declined by 7.4 percent in the 2009 fiscal year. State general fund spending declined by 3.4 percent, only the second time since 1979 that states experienced a nominal decline in general fund spending. Balances and rainy day fund levels fell from 8.6 percent of expenditures in the 2008 fiscal year to 4.8 percent of expenditures in the 2009 fiscal year, below the historical average of 5.5 percent. Not surprisingly, the number of states making midyear budget cuts increased exponentially. Forty-three states were forced to make midyear budget cuts in 2009, more than cuts made from the 2004 fiscal year through the 2008 fiscal year combined.

The 2010 fiscal year has not been any kinder to state finances. Revenues have continued their downward trajectory, with tax collections declining by 10.9 percent and 4.1 percent respectively in the first two quarters of the fiscal year. The continued decline in state economic conditions has caused the vast majority of states to miss their revenue projections for the year, with 41 states experiencing revenues lower than projected through February. State spending is expected to decrease by at least 5.4 percent, the first time on record that state spending has declined two years in a row. Nineteen states have had to cut their 2010 fiscal year budgets up to 5 percent, with another 24 states making cuts greater than 5 percent.

The fiscal health of states would be even more dismal if not for the funds contained in the American Recovery and Reinvestment Act, which Congress passed in February 2009. But Recovery Act funds alone have not been enough to solve states’ fiscal difficulties. States have already closed $89.8 billion in budget gaps in the 2010 fiscal year, and face at least $136.1 billion in remaining budget gaps through the 2012 fiscal year. Fiscal conditions are not expected to noticeably improve in 2011 either. While the national recession may have ended in August or September 2009, state revenues typically do not rebound until two years after an economic recovery begins. This is partly due to the fact that states’ revenue collections do not markedly improve until job hiring begins in earnest. Additionally, states will face a large drop-off in Recovery Act funds in the 2011 fiscal year, potentially creating a new round of budget shortfalls. As a result, states will be forced to make painful budgetary decisions in fiscal 2011 and beyond, and will need to re-examine the roles and responsibilities of state government.

The Current State Fiscal Condition

Revenues in the 2009 Fiscal Year

While the 2008 fiscal year saw modest revenue growth of 2.2 percent1, revenue growth turned sharply negative in the 2009 fiscal year. Combined revenue collections of sales, personal income and corporate income declined 7.4 percent in the 2009 fiscal year from 2008 levels. Individually, sales tax collections decreased 4.7 percent, personal income tax collections declined 8.2 percent, and corporate income tax collections were 16.1 percent lower. In actual dollar terms, sales tax revenues declined by $8.4 billion, personal income tax revenues shrank by $17.2 billion and corporate income tax collections decreased by $5.8 billion.2 Another indication of the severity of the revenue strain states faced in the 2009 fiscal year is that revenue collections from all sources3 were lower than anticipated in 41 states, on target in another four states and were higher than budgeted amounts in only four states. By comparison, in the 2008 fiscal year, 20 states had lower than projected revenue collections, five states met projections and 25 states exceeded projections.4

Revenues in the 2010 Fiscal Year

Unfortunately for states, the revenue outlook has not improved in the 2010 fiscal year. The latest information from the Nelson A. Rockefeller Institute of Government illustrates this point. According to preliminary figures for the second quarter of the 2010 fiscal year, 39 of 46 early reporting states are reporting declines in revenue collections. Overall, states are experiencing a 4.1 percent decline in revenue in the second quarter of the 2010 fiscal year, following a 10.9 percent decline in the first quarter. Total revenue collections have now fallen for a record five consecutive quarters on a year-over-year basis.5

When passing their 2010 fiscal year budgets, states were more hopeful that revenue declines would be more moderate in 2010. States projected revenues from sales, personal income and corporate income taxes would be 1.4 percent lower than those collected in the 2009 fiscal year. Specifically, states projected sales tax collections to increase 0.7 percent, personal income tax collections to decline 2.5 percent and corporate income tax collections to decline an additional 6.3 percent.6 It should be noted that most states passed their 2010 fiscal year budgets in the spring of 2009, nearly a year ago. As a result of the continued weakness in the job market and sluggish sales, few states are currently meeting revenue projections. According to a short survey conducted in February by the National Governors Association and NASBO, 41 states are experiencing revenue collections lower than projected, six states are on target and only three have revenues higher than projected. The continued decline in revenue has led to budget shortfalls in all regions of the country. States face $136.1 billion in remaining budget gaps for fiscal 2010-12, even after previously closing $89.8 billion in 2010 fiscal year budget shortfalls.7

Tax and Fee Changes in the 2010 Fiscal Year

In addition to budget cuts and the use of rainy day funds and balances, many states enacted tax and fee increases in the 2010 fiscal year in order to balance their budgets. Overall, states enacted a net tax and fee increase of $23.9 billion. This marks the highest dollar amount since the Fiscal Survey of the States began tracking tax and fee changes in 1979. In total, 29 states enacted net increases while nine states enacted net decreases.

Personal income taxes comprised the largest enacted revenue increase for the 2010 fiscal year, totaling $10.7 billion. The largest enacted increases were seen in California and New York. Twelve states enacted overall increases in personal income taxes, while six states enacted net decreases. The net decreases were relatively minor, with North Dakota enacting the largest decrease at $49 million.

Personal income taxes were far from the only type of enacted revenue increase in the 2010 fiscal year. States also enacted increases of $6.1 billion in sales taxes, $5.3 billion in fees, $967.8 million in other taxes, $908.1 million in cigarette and tobacco taxes, $54.1 million in alcohol taxes, and $42.3 million in motor fuel taxes. Corporate income taxes were the only category in which states enacted a net decrease, by $202.2 million.8

State Spending in 2009

General funds serve as the primary source for financing a state’s operations. General funds typically receive their revenue from broad-based state taxes such as sales taxes and personal income taxes. In the 2009 fiscal year, state general fund expenditures were $663.9 billion (preliminary actual), a 3.4 percent decline compared to the 2008 fiscal year. The 2009 fiscal year marked only the second time since 1979 that states experienced a nominal decline in general fund spending; the 32-year historical average of spending growth is 5.6 percent.9 In contrast to the 2008 fiscal year, all regions of the country experienced some form of a spending slowdown in 2009. In 2008, only six states reported negative expenditure growth, 35 states reported growth that was positive but less than 10 percent, and nine states had growth rates of 10 percent or higher.10 Several states that were most severely impacted by the housing market decline, such as Arizona, Florida and Nevada, were forced to enact negative growth budgets in the 2008 fiscal year. By the 2009 fiscal year, however, the downturn had become much more universal. Twenty-eight states reported negative expenditure growth in 2009, 19 states had growth that was positive but less than 5 percent, and only three states experienced growth greater than 5 percent.11

The American Recovery and Reinvestment Act in February 2009 created a large influx of federal dollars to the states and produced a shift in the funding sources for state expenditures. In the 2008 fiscal year, general funds accounted for 45.7 percent of total state spending, federal funds were 26.3 percent, other state funds were 25.7 percent, and bonds reflected 2.4 percent. In the 2009 fiscal year, general funds are estimated to account for 41.7 percent of total state expenditures, federal funds 30 percent, other state funds 25.6, and bonds are estimated to reflect 2.7 percent.12 Additionally, while general fund spending declined in the 2009 fiscal year, federal fund spending is estimated to increase by 21.2 percent.13

Elementary and secondary education remained the largest category of general fund expenditures in 2009, accounting for 35.1 percent of general fund expenditures. Medicaid represented 16.2 percent, and higher education accounted for 11.1 percent. Combined, Medicaid and education comprised more than 62 percent of total state general fund spending. Other categories of general fund spending included corrections at 7.2 percent, public assistance at 1.9 percent, transportation at 0.7 percent, and all other spending14 at 27.8 percent.

While elementary and secondary education remains by far the largest category of general fund expenditures, K-12 and Medicaid represent nearly the same level of total state expenditures. In fiscal 2009, elementary and secondary education is estimated to account for 21.1 percent of total state expenditures, with Medicaid close behind at 21 percent. Since Medicaid is a long-term health care program for low-income individuals, however, Medicaid spending is expected to increase sharply as more individuals continue to feel the impact of the economic downturn. Nearly 3.3 million more people were enrolled in Medicaid in June 2009 compared to June 2008, according to the Kaiser Family Foundation.15 Other categories of total state spending for 2009 included higher education at 9.8 percent, transportation at 8.2 percent, corrections at 3.3 percent, public assistance at 1.6 percent, and all other spending at 34.9 percent.16

State Spending in 2010

According to appropriated budgets, general fund expenditure growth is expected to decrease by an additional 5.4 percent in the 2010 fiscal year. This will mark the first time in at least several decades that state spending growth has declined two years in a row.17 General fund spending is estimated to be $627.9 billion in the 2010 fiscal year, a $36 billion decrease from fiscal 2009. Compared to the 2008 fiscal year, general fund spending is expected to decrease $59 billion.18 Not surprisingly, the number of states enacting negative growth budgets greatly increased in the 2010 fiscal year. Thirty-seven states reported negative growth budgets, while another 11 states enacted budgets with spending growth ranging from no growth to 4.9 percent, and only two states enacted budgets with spending growth over 5 percent.19

Additionally, it is likely that the final figures for the 2010 fiscal year will show state spending growth declined by even more than 5.4 percent. As of February, states had already closed, or are currently facing, a cumulative $108.7 billion shortfall in the 2010 fiscal year, and are potentially facing a $55.4 billion shortfall in the 2011 fiscal year. These massive shortfall amounts will lead to even further spending reductions in the 2010 fiscal year.20

Budget Cuts

The number of states forced to make midyear budget cuts increased exponentially in the 2009 fiscal year. More states made midyear budget cuts in 2009 than in the 2004 to 2008 fiscal years combined. Forty-three states made midyear cuts in the 2009 fiscal year,21 while 18 states made cuts in 2004, five in 2005, two in 2006, three in 2007 and 13 in 2008. States made budget cuts in a wide range of areas in 2009. Thirty-three states cut higher education, 29 states reduced personnel, 29 cut K-12 education, 28 reduced corrections spending, and 27 made cuts to Medicaid.22

The number of states making budget cuts has not abated in the 2010 fiscal year. Through February, 19 states have made budget cuts up to 5 percent, while another 24 states have made cuts greater than 5 percent.23 It should also be noted that even if the national recession ended earlier in the 2010 fiscal year as most economists believe, states will likely be forced to make midyear budget cuts for several years to come since states typically lag the economy as a whole in recovering from an economic downturn. Evidence of this can be seen in the fact that 37 states made midyear budget cuts in the 2003 fiscal year, well after the 2001 recession ended.

Balances

Total balances include both ending balances and the amounts in states’ budget stabilization funds. They also reflect the funds states may use to respond to unforeseen circumstances after budget obligations have been met. Forty-eight states have either a budget stabilization fund or a rainy day fund, with about three-fifths of the states having limits on the size of these funds.24

Balances, like spending growth, declined in the 2009 fiscal year. Balances were 4.8 percent of expenditures ($32 billion), considerably less than the 2008 fiscal year when balances were 8.6 percent of expenditures ($59.1 billion). As recently as the 2006 fiscal year, balances were at record high levels of 11.5 percent of expenditures ($69 billion). The informal rule-of-thumb is that balances should be at least 5 percent of expenditures. While the 2009 fiscal year’s 50-state average balance level of 4.8 percent may seem like a significant cushion, two states—Alaska and Texas—represent 48 percent of total balance levels. Without those two states, total balance levels drop to 2.7 percent of expenditures. Over the last 32 years, balances have averaged 5.5 percent of general fund expenditures.25

Looking Ahead

Negative fiscal conditions are expected to persist in most states for the remainder of 2010 and throughout the 2011 fiscal year. Even though the national recession likely ended in the second half of the 2009 calendar year, many states will likely face several more years of negative or slow revenue growth. Typically, state tax revenues remain weak for several years after a recession ends. For example, it took state revenues at least five years to fully recover after the last two recessions.26 Tax collections are not expected to fully recover until the job market improves, which would lead to increased personal income tax collections and more consumer spending.

There are few, if any, signs of a rapid improvement in the labor market. Unemployment rates increased in 31 states in January,27 and the Council of Economic Advisers assumes near double-digit unemployment for the rest of 2010.28 States are also expected to face increased demand for services even as revenues remain weak. Case in point, Medicaid enrollment is projected to continue to increase even as the national economy begins to recover.29 States are also very concerned about the impact of decreasing Recovery Act funds. Increased federal funds from the Recovery Act have been instrumental in helping states avoid even more draconian cuts. States face a cliff in the 2011 fiscal year as Recovery Act dollars rapidly drop off. The low revenue growth, increased demand for services and the end of Recovery Act funding have led credit rating agencies to rate states’ outlook as negative.30

Furthermore, due to balanced budget requirements, states will continue to be forced to use rainy day funds and balances, examine tax and fee increases, and make painful spending reductions in some areas of the budget while at the same time facing increased demands for services in other areas. States have begun discussing the new normal, in which spending and revenue growth will remain well below historical averages through the foreseeable future. All these factors combined have the potential to lead to a painstaking re-examination of the roles and responsibilities of state government. Some states have already begun this process by creating reform and streamlining commissions, partly designed to determine the core responsibilities of states and ways to make state government more efficient. Increased demand for performance and results, along with austere state budgets, have created an environment in which there exists a tremendous opportunity for reform.

Notes

1. National Association of State Budget Officers, The Fiscal Survey of States, (December 2008), 15.

2. The Fiscal Survey of States, (December 2009), 50, 52.

3. “All Sources” includes revenues from sales, personal income, corporate income, gaming taxes and all other taxes and fees.

4. The Fiscal Survey of States, (December 2009), 17.

5. Nelson A. Rockefeller Institute of Government, State Revenue Flash Report, (February 2010), 1.

6. The Fiscal Survey of States, (December 2009), 19.

7. National Governors Association and National Association of State Budget Officers, State Fiscal Update – February 2010, 2.

8. The Fiscal Survey of States, (December 2009), 17-19.

9. The Fiscal Survey of States, (December 2009), 8.

10. The Fiscal Survey of States, (December 2008), 7.

11. The Fiscal Survey of States, (December 2009), 9.

12. National Association of State Budget Officers, 2008 State Expenditure Report, (Fall 2009), 2.

13. 2008 State Expenditure Report, (Fall 2009), 9.

14. “All Other” spending in states includes the State Children’s Health Insurance Program (SCHIP), institutional and community care for the mentally ill and developmentally disabled, public health programs, employer contributions to pensions and health benefits, economic development, environmental projects, state police, parks and recreation, housing, and general aid to local governments.

15. Kaiser Family Foundation’s Commission on Medicaid and the Uninsured, Medicaid Enrollment: June 2009 Data Snapshot, (February 2010).

16. 2007 State Expenditure Report, (Fall 2009), 8.

17. See note 12 above.

18. The Fiscal Survey of States, (December 2009), 31-37.

19. See note 14 above.

20. See note 10 above.

21. The Fiscal Survey of States, (December 2009), vii.

22. The Fiscal Survey of States, (December 2009), 5.

23. State Fiscal Update – February 2010, 2.

24. National Association of State Budget Officers, Budget Processes in the States, (Summer 2008), 67-69.

25. The Fiscal Survey of States, (December 2009), 25-26.

26. Nelson A. Rockefeller Institute of Government, Fiscal Features: What will Happen to State Budgets When the Money Runs Out?, (February 2009), 2.

27. Bureau of Labor Statistics, Regional and State Employment and Unemployment Summary, (January 2010).

28. Council of Economic Advisers, Economic Report of the President, (February 2010).

29. Kaiser Family Foundation’s Commission on Medicaid and the Uninsured, State Fiscal Conditions and Medicaid, (February 2010).

30. Moody’s Public Finance, Annual Sector Outlook for U.S. State Governments, (February 2010), 1.


About the Author

Brian Sigritz is the director of State Fiscal Studies at the National Association of State Budget Officers.  He received his M.P.A. from George Washington University and his B.A. from St. Bonaventure University.  Prior to working at NASBO, Sigritz worked for the Ohio Senate and the Ohio House of Representatives.