September 15, 2004

FEDERAL POLICIES ARE WORSENING MISSOURI’S BUDGET PROBLEMS
 By Nicholas Johnson, Iris J. Lav and Amy Blouin [*]

Summary
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Federal policies were a major cause of the severe fiscal crisis Missouri has experienced over the past few years.  The cost to the state of federal policies over the past four years — fiscal years 2002 through 2005 — has been $3.6 billion, an amount that exceeded the $2.3 billion state budget deficit Missouri experienced over that period.  Most of these federal policies represent an ongoing problem and will continue to hamper Missouri’s efforts to recover from the crisis and provide an adequate level of government services to its residents.  Federal policies are likely to continue to cost the state more than $1 billion a year over the next several years.

The federal policies that have contributed to the fiscal crisis in Missouri and other states include tax cuts that reduce state revenue because of the linkages between federal and state tax systems, the federal ban on state taxation of purchases made over the Internet and other preemptions of state taxing authority, “unfunded mandates” such as the No Child Left Behind education initiative, and the shifting of prescription drug costs from the federal government to the states.  In 2003 the federal government enacted a temporary program of aid to states, which provided $376 million to Missouri.  But this aid offset only about one-tenth of the $3.6 billion cost to Missouri of federal policies during the state fiscal crisis.

Missouri has been particularly hard hit by these federal policies.  The $3.6 billion in additional spending obligations and lost revenues resulting from federal policies over the past four years represent approximately 13.0 percent of the state’s general revenue.  This is a greater percentage than in all but three other states.  Only Florida, Mississippi and Nevada have taken larger hits.

To cope with the fiscal crisis of the past four years, Missouri and its local governments have made cuts in government services that have affected millions of middle- and low-income families.  There also have been tax and fee increases to close deficits at both the state and local level, creating additional burdens for families.  If federal policies had been less costly for the state, or if the federal government had provided more funds to assist Missouri in its crisis, these program reductions and tax and fee increases could have been far less painful.

The impact on Missouri families of the actions taken by state and local government in response to the fiscal crisis has been substantial:

Table 1

The Cost to Missouri of Harmful Federal Policies, 2002-2005

FY 2002

$710 million

FY 2003

$774 million

FY 2004

$1.0 billion

FY 2005 (proj.)

$1.1 billion

Total

$3.6 billion

The federal tax cuts enacted in 2001 through 2003 are a major reason the federal government has pursued the policies that have worsened fiscal problems in Missouri and other states.  At a time when the federal government could have been ameliorating states’ fiscal problems, it instead has been cutting taxes, with most of the tax cuts targeted to high-income households.  It is therefore instructive to compare what Missourians have gained from these federal tax cuts to what they have lost from the cuts in state and local services.

For a small number of very-high-income Missouri residents, the benefits of the federal tax cuts have probably outweighed the direct costs of state and local budget difficulties.  For example, this year the wealthiest 1 percent of Missouri residents — a group with an average annual income of $722,000 — will receive an average benefit of $47,969 from the 2001-2003 tax cuts, according to the Institute on Taxation and Economic Policy.[1]

For a large number of lower- and middle-income Missourians, however, the benefit of the tax cuts is likely to be outweighed by the harm done by state and local budget cuts.  For instance:
  • In 2004, the average federal tax cut for a Missouri taxpayer in the middle fifth of the income spectrum is $846.  That is half the average tuition increase for a University of Missouri student and well under the tuition increases at many other public colleges and universities as well.
  • In 2004, the average federal tax cut for Missouri taxpayers in the poorest 60 percent of households is $458.  That is a fraction of what it would cost a working parent who has lost state-funded health coverage to purchase insurance in the individual market for a year.

  •  In 2004, about 28 percent of U.S. taxpayers are receiving a tax cut of $100 or less, according to the Urban-Brookings Tax Policy Center.  That is less than the increase in property taxes paid by the owner of a $100,000 home in a typical school district that has raised taxes to compensate for state shortfalls in education funding.

In essence, low- and middle-income Missourians have been paying for very generous federal tax cuts for the highest-income Americans and will continue to do so unless federal policies are changed.

 

Federal Policies’ Adverse Impacts on the Missouri Budget

Federal policies have made Missouri’s fiscal crisis deeper and more prolonged by: a) reducing state revenue directly, b) restricting Missouri’s ability to raise revenue, c) underfunding programs that Missouri and its localities operate, and d) imposing new costs on the state.  Taken together, these federal policies cost Missouri $710 million in fiscal year 2002, $774 million in 2003, $1.0 billion in 2004, and a projected $1.1 billion in 2005.  Although the $376 million in federal fiscal relief provided in 2003 has helped Missouri, the federal government could have done more to help it and other states avert damaging budget cuts and regressive tax increases.

Reducing State Revenue and Preempting State Taxing Authority

Because state tax systems are tied to the federal tax code in a number of ways, certain provisions of the federal tax cuts enacted in 2001, 2002, and 2003 have reduced state revenues as well as federal revenues.  For example, Missouri is losing $219 million in revenue through fiscal year 2005, and $566 million through fiscal year 2007, from the phase-out of the federal estate tax credit.[2]  This credit reduces the federal estate tax by a dollar for each dollar paid in state estate taxes.  Formerly, each state levied a state estate tax that was tied to this federal credit; most states simply set their own estate tax at a level equal to the federal credit.  Thus, the elimination of the federal credit effectively eliminates state estate taxes in most states.

Some 17 states and the District of Columbia have “decoupled” their estate taxes from this change in federal law in order to maintain their own estate tax.  Missouri, though, failed to do so, and is losing hundreds of millions of dollars of revenue as a result.

In another example, Missouri is losing $208.6 million through fiscal year 2005 from a business tax cut known as “bonus depreciation.”  As originally enacted, this federal tax cut allowed businesses to deduct immediately 30 percent of the cost of equipment they purchase, rather than writing off the cost gradually over the equipment’s useful life.

Like most states, Missouri ties its depreciation tax rules to the federal rules.  After bonus depreciation was enacted in 2002, the state “decoupled” from the federal tax cut, but only for one year.  Also, federal policymakers made the federal depreciation tax cut even more generous in 2003, allowing firms to deduct immediately 50 percent of the cost of equipment they purchase and extending the tax cut through December 2004.  These changes made bonus depreciation even more costly for Missouri.

Federal policies also prevent Missouri from raising revenues in certain areas.  The Internet Tax Freedom Act, for example, bars states from collecting taxes on the monthly charges people pay for Internet access.  This ban is costing Missouri more than $83 million over fiscal years 2002-2005.[3]  Of course, Missouri and other states might choose not to tax Internet access even if the federal government allowed it.  But the federal ban precludes even the possibility.

Table 2

Missouri’s Lost Revenue from Selected Federal Policies, 2002-2005

Ban on taxing Internet purchases

$1.1 billion

Phaseout of estate tax credit

$219 million

Bonus depreciation

$209 million

Ban on taxing Internet access fees

$83 million

Missouri is losing much larger amounts — at least $1.1 billion over that same four-year period — as a result of federal restrictions on states’ ability to tax purchases made over the Internet or in catalogs.  Two Supreme Court decisions bar states from requiring sales taxes to be remitted when the vendor does not have a physical presence in the state.  As a result, states generally cannot compel out-of-state sellers to collect sales taxes on Internet or catalog purchases, even though states can collect sales taxes if the same items are bought in a store.  This inconsistency hurts small businesses and in-state retailers by making them less competitive with Internet and catalog sellers.  It also prevents states and localities from collecting significant amounts of revenue that otherwise would be due to them.  Congress could fix this problem, as the Court has suggested, but it has not done so.

In the past, an argument against federal action to enable states to collect sales tax on catalog and Internet sales has been that as a result of differences among state sales tax systems, a requirement to collect and remit sales tax would impose too great a burden on the out-of-state vendors.  In the last few years, however, states have made substantial progress under their “Streamlined Sales Tax Project” in harmonizing state sales tax systems in ways that will substantially reduce the burden of collecting these sales taxes.  Missouri representatives have participated in this project, but the state has not yet enacted legislation to harmonize its state tax system with those of other states, in part because it would require changes to how certain businesses collect the tax.[4]  Were Congress to allow the collection of remote sales taxes by states that participate in the project, however, Missouri likely would choose to do so.

Donald Bruce and William Fox of the University of Tennessee estimate that Missouri’s inability to tax Internet purchases is costing the state and its local governments more than $290 million this year alone.[5]  Not all of this amount actually could be collected under a politically feasible solution to the problem.  The state would have to compensate vendors for collecting the tax, and some exemptions would be needed to protect small vendors.  A reasonable estimate is that the federal government’s failure to address this problem is costing Missouri state and local governments at least $1.1 billion over the four-year course of the state fiscal crisis, or some 90 percent of the estimate by Bruce and Fox.

Beyond the Internet Tax Freedom Act and the E-commerce problem, there are many other examples of federal preemption of state taxing authority, though they tend to be harder to quantify.[6]

Underfunding Programs and Increasing State Costs

Over time, the federal government has placed an assortment of requirements on state and local governments without providing adequate funding.  Many of these unfunded mandates, or underfunded obligations, are difficult to quantify, such as new responsibilities imposed on state and local governments in the area of homeland security.  (See the box below.)  For illustrative purposes, we focus on three areas: the education of disabled children, the Leave No Child Behind law, and new election reform requirements.
  • The Individuals with Disabilities Education Act (IDEA), enacted in 1975 and most recently amended in 1997, guarantees each disabled child an assessment and an individualized education plan.  When the law was enacted, the federal government promised it would fund 40 percent of the additional costs that the law requires states to incur.  In Missouri, federal funding over fiscal years 2002-2005 has fallen nearly $858 million short of meeting this goal.[7]
  • The No Child Left Behind Act requires schools to take a variety of specific steps with respect to the educational testing of children, including requiring school districts to pay for tutors and school transfers when schools are not meeting certain standards.  The federal government, however, has not provided the promised level of support.  During the four years of the state fiscal crisis, Missouri’s funding has been approximately $469 million below the levels authorized in the Act.  Moreover, this is a conservative estimate, because it is unclear how much it will cost states and localities to meet all of the new mandates in this law.

Underfunding Homeland Security? 

Ever since the tragedy of September 11, 2001, states and localities have received a host of new federal mandates intended to improve preparedness, strengthen food and agriculture security, upgrade interagency communication, and safeguard the water supply.  To help meet the additional costs, the federal government has increased some grants to states and localities and created new grant programs.  To date, however, no comprehensive study has been undertaken of whether states and localities have received sufficient federal aid to meet these new homeland security initiatives.

In addition, some estimates indicate that substantial new funding will be needed for upgrades in several areas, such as telecommunications, water systems, and airport security.  Yet no consensus exists regarding the appropriate division of responsibility among federal, state, and local governments for funding the desired upgrades.

In the absence of data assessing Missouri’s specific homeland security needs, we have excluded homeland security costs from this analysis.  It is clear, however, that these costs are significant.  The city of St. Louis, for instance, estimates that it spent $4 million in fiscal year 2003 alone to upgrade security at the city’s airport.  According to city officials, federal funds covered only a portion of these costs; the rest were financed from city tax dollars.a
a Interview with Paul Payne, Deputy Director, St. Louis City Budget Division, July 2004.
  • The Help America Vote Act was intended to provide federal guidelines — and resources — for local precincts to update their voting technologies.  Although the federal government has made a substantial commitment to fund new election equipment in 2004, minimal funding is expected in 2005, despite the slim likelihood that all problems will be resolved by then.  In Missouri, the funding shortfall is about $12 million over four years.

Unfunded mandates are not new, but the recent confluence of the state fiscal crisis and both new and old mandates is making life increasingly difficult for Missouri’s state and local governments.  Federal requirements related to the No Child Left Behind Act, for example, are continuing to grow even though Missouri now has few resources to cover such new costs.  The National Conference of State Legislatures recently estimated that unfunded mandates cost Missouri $522 million this year alone.[8]  This report, which considers a narrower set of mandates, finds the four-year cost during the state fiscal crisis to be approximately $1.3 billion.

The Federal Role in Rising State Medicaid Costs 

Much has been made of the rapid growth in Medicaid costs, in Missouri and other states.  This growth is largely the result of rising health care costs generally.  However, it also reflects a gradual shift, from the federal Medicare program to state Medicaid programs, in the responsibility of caring for low-income elderly and disabled people who are covered by both Medicare and Medicaid.  Such individuals are sometimes called “dual eligibles.”

Dual eligibles have their hospital stays paid for by Medicare and some outpatient services and pharmaceuticals paid for by Medicaid.  In recent years, changes in the provision of health care have led toward shorter hospital stays and a greater reliance on outpatient services and pharmaceuticals to manage health conditions.  This trend has pushed costs from Medicare to Medicaid, and hence from the federal government to the states.  (While Medicare is entirely federally funded, Medicaid costs are shared by the federal government and the states;  Missouri pays about 39 percent of Medicaid costs in federal fiscal year 2005.)

The effects of this trend are quite significant:  in Missouri, some 70 percent of all Medicaid expenditures, and 88 percent of Medicaid pharmaceutical expenditures, are made on behalf of low-income elderly and disabled individuals, most of whom are dual eligibles.[9]  Missouri is spending roughly $784 million for outpatient prescription drugs for this population in fiscal years 2002-2005.

The 2003 Medicare drug law will leave states responsible for the large majority of these drug costs even after the new Medicare prescription drug benefit takes effect.  Under the drug law, dual eligibles will receive drug coverage through Medicare beginning in 2006.  This could produce significant savings for state Medicaid programs.  Yet the drug law requires states to return the bulk of these savings to the federal government in perpetuity.

Table 3

Missouri’s Added Costs from Selected Federal Policies, 2002-2005

Educating disabled children

$858 million

Drug coverage for low-income elderly

$784 million

No Child Left Behind requirements

$469 million

Updating voting technologies

$12 million

Moreover, states face new, unreimbursed costs over the next three years for implementing the new Medicare law.  The Congressional Budget Office estimates that these costs will reach $1.2 billion; Missouri’s share could well reach into the tens of millions of dollars.

 

The Fiscal Crisis and Missouri’s Response

The costly federal policies described above have occurred at a time when Missouri has struggled to balance its budget.  Missouri’s fiscal crisis began in state fiscal year 2001 with an announcement of a projected $75 million budget shortfall.  Additional shortfalls emerged over the next four years, as revenues declined as a result of the national recession and other factors.  Over fiscal years 2002-2005, Missouri faced a cumulative shortfall of $2.28 billion.

Table 4
“Core Reductions” to Missouri Budget, by Department and Fiscal Year In Millions of Dollars

 

Department

FY

2002

FY

2003

FY

2004

FY

2005

 

Total

Department Cuts as % of Total Core Cuts

Elementary & Secondary    Education

 $20.1

 $62.1

 $58.0

 $22.6

 $162.8

 $11.7%

Higher Education         

9.6

99.7

42.9

1.3

153.5

11.0%

Social Services

88.3

303.6

110.6

55.3

557.8

40.1%

Mental Health

11.2

36.5

27.6

12.5

87.8

6.3%

Health

3.4

12.1

13.6

2.4

31.6

2.3%

Public Safety

5.6

5.2

8.4

0.9

20.2

1.4%

Corrections

12.8

39.1

6.4

20.8

79.0

5.7%

All Other State Departments

56.7

129.0

75.8

35.8

297.2

21.4%

Total

$207.8

$687.3

$343.2

$151.6

$1,389

100.0%

Source: Missouri Office of Administration. 

Note:  Some of these cuts may have been restored in later years;  the vast majority of the cuts have not been restored, but the exact proportion has not been calculated by the Office of Administration.

Missouri law requires a balanced budget, so over those four years, the state has enacted a mix of spending cuts, revenue increases, and other measures to bring the budget into balance.  Most of the $2.28 billion budget gap has been closed through what are termed “core reductions” — cuts in the level of spending below what would be necessary to maintain public services at a constant level.  These core reductions have totaled $1.4 billion.  Another $900 million has been saved through “withholds,” or temporary, mid-year reductions in agency spending.

The state has also shifted some costs to future years and accelerated some revenue collections, preventing even deeper spending cuts now but making it more difficult to balance the budget in later years.  For example, the state identified $275 million in capital projects that in previous budgets it had planned to pay for in cash and instead sold bonds to pay for them, using the cash savings to help balance the current budget.  These bonds will have to be repaid in the future.  In addition, the state used much of the revenues it received from the national tobacco settlement, averaging $150 million per year, to plug general fund holes and fund ongoing health expenditures, leaving less money available to pay for such items as anti-smoking programs than had been expected.

As shown in Table 4, some 40 percent of the core reductions came in the Department of Social Services, which oversees most state programs designed to assist low- and moderate-income families.  K-12 education and higher education accounted for another 23 percent of the budget cuts, while mental health and corrections accounted for about 6 percent each.

It is worth noting that even before these cuts were enacted, Missouri had one of the nation’s leanest state governments.  In fiscal year 2000, Missouri ranked 41st among the states in terms of state government spending as a share of personal income, according to U.S. Census data; on a per capita basis, it ranked 45th.  Taking into account both state and local spending, government spending in Missouri ranked 48th among all states.

The funding reductions have had substantial impacts on state services such as health care, assistance to people with disabilities, and higher education.

Health Care

Reductions in the state’s Medicaid program, which provides health insurance to low- and moderate income children, families, seniors, and people with disabilities, have largely been implemented by reducing the program’s income ceiling.  As many as 96,000 parents, seniors, and people with disabilities are estimated to have lost coverage as a result.  Another 30,000 women have lost coverage through cuts in a separate health care program.  Specifically:
  • An estimated 37,320 working parents lost Medicaid coverage when the state eliminated Medicaid eligibility for working parents with incomes between 75 percent and 100 percent of the poverty line.[10]  (For a family of three in 2004, this means that families with incomes between $14,137 and $18,850 lost coverage.)  Since most jobs at this wage level do not provide affordable health coverage, it is likely that most of those parents are now uninsured.
  • Some 18,322 Missourians lost state-funded health insurance when the state tightened eligibility for several other Medicaid programs for working parents, including a program that provided Medicaid to very low-income non-custodial parents who were current in their child support.
  • Tens of thousands of Missouri seniors and persons with disabilities have lost access to Medicaid coverage since July 2002, when the state scaled back a Medicaid “spend-down” program that allowed people to receive Medicaid if their health care bills otherwise would reduce their incomes below the poverty line.  It is estimated that 40,700 seniors per year who might have received coverage have not be able to because of those changes.

    It is important to note that even as many of those seniors and people with disabilities lost access to Medicaid coverage, others were coming onto the rolls; the total number of seniors and persons with disabilities receiving Medicaid actually has risen from 201,000 in August 2002 to 224,000 in May 2004.  This increase results in part from factors like the weakening economy, declining availability of private-market health insurance, and demographic changes.  It also results in part from a previously enacted increase in the income eligibility limit that was phasing in over a three-year period.  Separating out the effects of these various factors is hard to determine, but it is clear that Missouri’s budget problems caused tens of thousands of seniors and people with disabilities to lose access to coverage for which they otherwise would have qualified.

    (Meanwhile, under a separate law that was enacted before the extent of the fiscal crisis was known, the state is expanding Medicaid eligibility for the elderly and disabled from 80 percent of the poverty line to 100 percent over three years.  The net effect of these changes remains unclear.)

These Medicaid reductions not only cost tens of thousands of Missourians their eligibility for health coverage, but also reduced reimbursements to health care providers such as doctors and hospitals.  For providers that care for large numbers of these newly uninsured, the revenue loss may be quite significant.

Mental Health 

Thousands of Missourians with mental disabilities have lost services due to cuts in the state’s Department of Mental Health.  Although some of the $87.8 billion in initial cuts were restored in later years, net reductions over the 2002-2005 period totaled about $58.2 million in state general revenue.  Nearly 600 jobs have been cut from the department.  Although some of the budget cuts were achieved with administrative efficiencies, consolidations and other changes, the cuts also resulted in reductions in the number of people with mental-health needs that could be served at state-operated facilities and at private community facilities that operate with state funding.[11]

Specific cuts have included:
  • A $4.7 million reduction in support for alcohol and drug treatment and prevention programs.  This has resulted in the loss of substance abuse treatment funding for approximately 4,000 individuals.
  • An $11 million reduction in funding for provide services for people with mental retardation and developmental disabilities.  Such services include respite care, day habilitation, and therapy.  As of July 2004, the department had a waiting list for residential services and non-residential services of more than 4,000 individuals, who must instead rely on care by their families — or go without needed specialized care.
  • The state's "family stipend" program — which helped some 800 families to care at home for their children with serious disabilities rather than institutionalizing them — was reduced in fiscal year 2003 and completely eliminated in fiscal year 2004.  The average annual stipend under this program was $766 in 2002.

Cuts Affecting At-risk Children

Other state budget cuts have hurt Missouri children and families:
  • Some 2,500 grandparents caring for grandchildren who would otherwise be in the state-supported foster care system had their monthly payments reduced from $188 to only $63.  The new level is one-quarter of the reimbursement given to non-relatives who provide foster care.
  • The state eliminated cash assistance for legal immigrants under the TANF program, costing some 394 families a monthly payment that averaged $292 per month for a family of three.
  • The eligibility ceiling for the state’s Child Care Assistance program, which provides child care subsidies to low-income families so the parents can maintain employment, has not been adjusted for inflation since 2002.  As a result, the maximum allowable income for a family of four has declined from 125 percent of the federal poverty line to 112 percent between 2002 and 2005, which means that families of four with incomes of roughly $21,000 to $24,000 are no longer eligible for a child care subsidy.  Such subsidies can be worth up to $281 per month or $3,370 per year.

 Higher Education

Between 2002 and 2005, the state has made $153 million in spending reductions for its colleges and universities.  Various colleges and universities have responded differently; some have scaled back course offerings or cut faculty.

One particularly visible result of the funding cuts has been dramatic increases in tuition:  since 2002, tuition increases have ranged from $150 to $630 at two-year colleges and from $888 to $1,743 at four-year colleges.  The largest increases have occurred at the state’s largest campuses, those of the University of Missouri at Kansas City, Rolla, St. Louis, and Columbia (See Table 5.)

Many of the 88,000 Missourians who attend the state’s public colleges and universities come from middle- and lower-income families and are likely to have difficulty absorbing these tuition increases, especially because state funding for grants and scholarships also has been reduced slightly.

Other Areas

 

Table 5

Core Reductions and Tuition Increases by College and University

Institution

FY 02-05 Core Cut 

Tuition Increase

Community Colleges

 

 

Crowder College

$740,000

$150

East Central College

$898,000

$390

Jefferson College

$1,318,000

$180

Metropolitan Community College

$5,476,000

$450

Mineral Area College

$864,000

$540

Moberly Area Community College

$824,000

$320

North Central Missouri College

$426,000

$330

Ozarks Technical Community College

$1,569,000

$630

St. Charles County Community College

$714,000

$270

St. Louis Community College

$7,874,000

$540

State Fair Community College

$916,000

$510

Three Rivers Community College

$573,000

$390

Linn State Technical College

$1,077,000