The financial problems racking many state governments this
year have less to do with the weak national economy than with the ability of governors and
legislators to manage money wisely.
That is the key finding of a USA TODAY analysis of how the
50 states spend, tax and balance their budgets — or don't.
The National Governors Association says states are
suffering their worst economic crisis since World War II. But for many states, the
analysis shows, the fault is largely their own.
Some states that have enjoyed handsome growth in tax
revenue nonetheless have huge budget shortfalls. At the other extreme, some of the
best-managed states suffered sharp declines in tax collections but promptly took painful
steps to balance their books.
Utah, Georgia and Delaware are the best financial stewards,
according to the USA TODAY analysis of the states' financial performance. The key to their
success: restraint. During the economic boom of the late 1990s, these states limited both
spending growth and tax cuts. After the economy weakened in early 2001, they acted swiftly
and decisively to keep their finances sound.
California, the worst-performing state in the analysis, did
the opposite. It approved huge spending increases and tax cuts during the boom. When the
economy soured, the state began borrowing money and using accounting gimmicks to avoid its
day of reckoning. Today, it continues to spend $1 billion a month more than it takes in.
The budget year ends next Monday in 46 states. All states
except Vermont have laws requiring a balanced budget, although many use accounting
maneuvers to skirt the requirement.
To make ends meet, some states have removed thousands of
low-income adults from Medicaid and reduced benefits for others. Many states have raised
college tuition, cigarette taxes and other narrowly targeted fees. Six states have
increased sales and income tax rates, and several more may do so this week.
But one thing has remained constant throughout the crisis:
State spending keeps growing.
It went up 6.3% for the fiscal year that ended June 30,
2002, and it's on track to rise about 5% in the 12 months that end June 30. The number of
people on Medicaid, which pays for health care and nursing homes for the poor, remains at
a near-record 40 million. That number is up 30% since 1998, the result of efforts to sign
up people who qualify. And despite anecdotal reports of layoffs — Oregon furloughed
130 state troopers, for example — state governments have added 74,000 workers (an
increase of 1.5%) in the past two years while the private sector has registered a net loss
of 2.6 million jobs (a decline of 2.4%).
By almost any measure, state governments have suffered less
than businesses and taxpayers during the economic downturn. Even so, nearly every state is
struggling to balance its books.
USA TODAY's analysis examined how well states manage their
finances — not the quality of life in those states. For example, a state's decision
to spend more money on schools without raising taxes might damage the state's finances,
but it could help children learn more. Similarly, a decision to cut highway programs would
improve the state's financial performance, but it could aggravate traffic congestion.
In states that manage money well, the benefits to residents
are often invisible: service cuts that don't occur, tax increases that aren't needed and
borrowing that doesn't have to be repaid by the next generation.
In California, Illinois and other states that have managed
money poorly, residents will be paying off added debt for decades. Tax increases and
spending cuts will be more severe than they would have been had the states addressed
financial difficulties quickly.
"We've slipped out of a tradition of good fiscal
management," says Donald Kettl, a political scientist at the University of Wisconsin
who studies state finances. "California is an extreme example."
The principles of good financial management at the state
level are the same as those for a household: Balance what you spend with what you make, or
you're headed for trouble. A state that spends too much or suffers a drop in tax revenue
has to raise tax rates, cut spending or borrow.
The longer it delays, the worse the problem gets.
Major conclusions
USA TODAY analyzed states' fiscal management by measuring
their taxing and spending habits over five years ending June 30, 2002, based on audited
financial statements. State bond ratings — Wall Street's subjective assessment of
financial health — and a ranking by Governing magazine also were considered. State
spending was adjusted for inflation and population growth.
Key findings:
•Spending growth during the boom years haunts some
states today. State spending was 38% higher in 2002 than in 1997 —$983 billion vs.
$710 billion. That was 18 percentage points higher than inflation and population growth
combined during the period. This shows that policy decisions — not just higher costs
and more people — drove spending to record levels.
Three types of spending fueled the expansion in state
budgets: education, health care for the poor and property tax relief in which states
reimbursed local governments for lost revenue. For example, a California program to reduce
class size in kindergarten through third grade cost $1.7 billion in 2003.
On the other hand, states that were frugal during the boom
are generally in the best shape today.
•The healthiest states avoided big tax cuts during the
economic boom. The conservatively managed states of Utah, Georgia and Delaware have cut
taxes and fees at half the national average since 1997, USA TODAY found. But tax cuts had
mixed effects elsewhere. Hawaii cut taxes, but it also cut spending and is in better shape
than it was five years ago. New York, in contrast, slashed tax rates at the same time that
it was sharply increasing spending. It is now borrowing and raising taxes.
In addition to spending and tax policy, another critical
factor in whether a state has sound finances is its politics:
•Powerful governors manage money better. States in the
best financial shape have governors with broad constitutional powers over spending.
Forty-three governors have line-item vetoes, which allow them to reject individual
programs within legislation. But governors in the top-ranked states usually have even
greater power. Most can cut spending without legislative approval if state revenue isn't
keeping pace with projections.
• Divided government promotes fiscal restraint. States
spend more when the same party controls both the legislature and the governor's mansion.
States increased spending 6.8% annually from 1997 through 2002 when one party controlled
state government, but only 5.9% when control was divided, USA TODAY found. That might seem
a small difference, but because of compounding, the effect on a budget can total hundreds
of millions of dollars after a few years.
On another front, tax cuts were only half as big when
government was divided.
Quick action stops trouble
How do the most fiscally responsible states do it?
"We dealt quickly, openly and aggressively with our
budget problems," says Utah Gov. Mike Leavitt, a Republican in his third term.
"Over time, the piper has to be paid. Delaying or using smoke-and-mirrors accounting
only magnifies the problem."
Utah has made hundreds of small but difficult changes to
balance spending and revenue, while keeping a small reserve fund to protect against future
problems. Spending cuts included releasing some prisoners early and eliminating such
Medicaid benefits as dental and vision coverage for adults and circumcisions for baby
boys. Tax increases included expanding the sales tax to cable television.
Utah's budget-balancing was made easier by its cautious
behavior during the boom. Spending grew 5 percentage points faster than inflation and
population growth from 1997 through 2002, compared with the national average of 18
percentage points.
What also set Utah apart from most other states is that it
didn't dawdle. The Legislature began adjusting this year's budget within weeks after the
fiscal year began last July.
Other states that acted decisively were Vermont and New
Hampshire. Those two increased spending faster than all other states because of
court-ordered increases in education spending. But they preserved their financial health
by raising taxes to pay for the new spending and by tightly controlling other costs.
How to manage a budget well is no secret. "Deal with
the problem early. Avoid accounting chicanery. Have a diversified revenue base. Don't
approve expensive programs and bet that an economic boom will pay for them," Kettl
says. "That's the key to fiscal health."
A political problem
Ohio Gov. Bob Taft won re-election in a landslide last
November.
In January, he proposed a plan to balance the state's
budget by raising taxes and trimming spending growth equally. His approval rating
immediately plummeted from 66% to 40%. The Republican-controlled Legislature ignored the
Republican governor and last week passed a budget that it had crafted itself. The governor
is expected to sign the two-year budget, which increases spending 11% and raises taxes a
record $3 billion.
Today's financial problems in state governments — gaps
of billions of dollars between what they want to spend and the taxes they take in —
are as much a political crisis as a financial one.
Polls show that voters want what they cannot have: more
spending and lower taxes simultaneously. Elected officials who deviate from this view have
been punished harshly whether they support spending cuts, tax increases or both.
"Politicians have no cover to make tough
decisions," says Eric Rademacher, director of the non-partisan Ohio Poll at the
University of Cincinnati. "The message to elected officials is: 'Tackle the budget
problem at your own peril.' "
Polls show that voters want to cut state spending in
theory, but not in practice. In a USA TODAY/CNN/Gallup Poll, 79% said they preferred
spending cuts to tax increases to balance state budgets.
Those who favored spending cuts were asked whether they
were willing to cut education funding: 77% said no. On health care funding, 78% said no.
Education and health care make up about two-thirds of state spending, so balancing budgets
by cutting spending is nearly impossible if those programs are off limits.
Facing an unforgiving electorate, governors and legislators
have mostly patched budgets, not repaired them.
"Doing as little as you can seems to be the
strategy," says Chris Atkins, director of tax and fiscal policy at the conservative
American Legislative Exchange Council.
Since tax collections started to weaken in January 2001,
states have drained reserve funds and used gimmicks such as delaying paychecks for a day
so the expense will count in the next year's budget. But mostly, states have borrowed
unprecedented amounts of money. A record 10% of state revenue last year was borrowed.
The National Governors Association says state financial
problems are the worst in 60 years. Sales and income tax collections, which account for
nearly half of state revenue, fell 4.8% for the fiscal year ended June 30, 2002, according
to the Census Bureau. Total revenue rose 1% during that time, according to a USA TODAY
analysis of state financial reports. But that was far below the 6.3% spending increase.
In this fiscal year, sales and income tax collections are
rising again, up 1.1% in the first six months. In addition, the federal government gave
states $10 billion in fiscal 2003 and will give another $10 billion in fiscal 2004 as part
of the tax-cut package President Bush signed into law last month. California will get $2.4
billion over two years, Florida almost $1 billion. Even so, many states have continued to
rely heavily on borrowing, reserve funds and accounting tactics to balance budgets.
Mixed-up politics
The public's conflicting demands — for more spending
but no tax increases — have resulted in a topsy-turvy political world.
Republican governors proposed higher taxes in Arkansas,
Connecticut, Georgia and elsewhere, although most were rejected or scaled back by
legislatures. Some Democratic governors, who often favor more government spending, are
emphasizing spending cuts.
"At some point, you can do permanent damage by
continuing to cut," says Idaho Gov. Dirk Kempthorne, a Republican who persuaded his
state's Legislature to pass a sales tax increase. "Raising taxes was not my first
choice, but it's part of leadership. I'm not going to preside over the dismantling of
essential government services."
In contrast, Wisconsin Gov. Jim Doyle, a Democrat, has kept
his campaign pledge to balance the budget without raising taxes.
"Democratic governors live in deathly fear of being
tarred as big-spending liberals," says Kettl of the University of Wisconsin.
"And Republicans are afraid of being seen as the politician who gutted
education."
Economic historian Richard Vedder says the public has
signaled how much government it wants. State and local spending has accounted for roughly
11% or 12% of gross domestic product for the past 30 years.
"When we get to the top of the range, there's a tax
revolt," says Vedder, of Ohio University. "When we get to the bottom, there's a
push for more spending. We revert back to the middle."
Last year, state and local spending reached 13% of gross
domestic product, the highest since record-keeping began in 1929.
That could indicate that states will now emphasize spending
cuts more than tax increases. Or it could represent a fundamental shift in what people
expect from state and local governments. Similar changes have occurred twice before: in
the Depression and during the 1960s, when new social programs added to state and local
spending.
Over the next few years, states will determine whether a
new era has begun: Will citizens pay permanently higher taxes in exchange for
better-funded public schools and health care? Or will they demand that taxes return to a
more comfortable level?
The narrow question is: Tax increases or spending cuts? The
broader question is: What do citizens want from government? In the boom, governors and
legislatures gave people what they wanted. In the downturn,people will decide whether to
pay for it.
Contributing: Paul Overberg |
