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State Budgets’ Unsound Structures

There’s been a lot of talk about state budget woes across the country as impacted by the Great Recession. However, beneath these cyclical declines in revenues are some far more daunting issues that states must confront to get themselves on a sustainable fiscal path.

Today in Phoenix, Brookings Mountain West and its Arizona partners are formally releasing an important new report we've done on the troubling state budget messes on display in California and three Mountain region states—Arizona, Colorado, and Nevada.

Produced by my group here at Brookings with University of Tennessee economist Matt Murray and the Morrison Institute for Public Policy at Arizona State University, the new study (entitled "Structurally Unbalanced") is meant to welcome Western legislators back to work with a clear comparative primer intended to motivate and inform the hard work of closing this year's daunting budget gaps and moving to reduce more entrenched longer-term problems. (Hey, welcome back lawmakers!)

Along these lines, the report--though focused on California and the three Intermountain states--serves as a kind guide to the varied ways almost all states have gotten into serious fiscal trouble in recent years.

At the center of our work is a key distinction between two types of budgetary trouble.

On the one hand, the large "cyclical" or deficits we flag in all of the Western states represent the temporary fallout of the Great Recession and its aftermath given the sharp and presently continuing decline of taxable economic activity in states. Ranging from 9 percent of stable general fund spending in Colorado to a whopping 17 percent of general fund spending in Nevada, these shortfalls are truly scary but at least will pass once the still-troubled Western economy picks up. In that sense, these gaps of hundreds of billions of dollars are the easier part the problem.

Harder because more entrenched, on the other hand, are what we call the states' "structural" deficits—the more or less permanent imbalances of revenues and expenditures that can arise from flaws in a state's fiscal structure, fundamental changes in the regional economy or the state's demographics, or, especially, imprudent or shortsighted policy choices. In Arizona, this sort of structural shortfall now adds up to a cool $2.1 billion—a chilling 21 percent of stable general fund expenditures. That structural gap is more than twice as mammoth on a percentage point basis as that of California, the leading poster-child for fiscal mismanagement.

But as I said the states in our report represent a catalogue of the varied ways states get in trouble. And that's true. Basically, the four Western states put on display four different styles of trainwreck that should be duly noted as cautionary tales elsewhere:

  • California basically enacted too many permanent spending increases (notably on education) during the boom and more recent good times even as it left in place a series of rigid voter mandates and tax limitations
  • Arizona, by contrast, basically gave away the store in better times by handing out a series of ill-advised tax cuts (total value, adjusting for inflation and growth: $2.9 billion since 1993) unaccompanied by spending cuts. Also a problem: Voter and court mandated spending on schools and Medicaid is combined with super-majority requirements for any revenue increase
  • Nevada, for its part, doesn't yet have a structural deficit (it just has a gargantuan 18 percent cyclical problem for FY 2011!) but it will soon. Here the problem is that the state's narrow, consumption and real estate-oriented revenue system may well now be ill-attuned to a post-Recession "new normal" in which migration, homebuilding, and gaming are permanently depressed
  • And finally there's Colorado. Colorado doesn't have a structural deficit, or even quite as large a temporary problem—it’s just damaging itself the slow way though adherence to its Taxpayer Bill of Rights (TABOR). Thanks to TABOR's spending and revenue raising limits, that is to say, expenditures and revenues track with each other but both are being inexorably ratcheted down. One indication of trouble: State funding for both K-12 and higher education as a percentage of personal income has declined precipitously under TABOR: from 35th in the nation in 1992 to 48th in 2006 and 2008, respectively, on both accounts.

In sum, there are few ways to completely avoid fiscal problems in bad times (well, a well financed rainy day fund can help) but there are many ways to create a deeper mess and they frequently begin in good times.

With that said, narrowness and rigidity and voter mandates sure turn up often as sources of trouble, which is why our report suggests that states wanting to improve their fiscal stability commit to a balanced approach (including of revenue- and spending-side responses), a broadening of the tax base, and the preservation of lawmakers' flexibility. Creatively restructuring government is also essential. Such adjustments—along with improved information sharing and budget processes—represent the only way states will be able to ease the present crisis while using it to get onto a more stable course into the future.

With many of them facing similar problems as legislatures reconvene this month, lawmakers in lots of places should study carefully the past mistakes and current predicament of the Western states.