Thursday, March 11, 1999
MOST STATES ILL-PREPARED FOR RECESSION
All But 8 Would be Forced to Raise Taxes
Cut Services Significantly in Future Downturn
View PDF file of complete report
More than three-quarters of state governments could not weather another recession like the one that struck in 1990 without significant cuts in programs and services or substantial tax increases. To avoid a repeat of the budget disruptions of the early 1990s, state governments on average need to hold reserve balances of 18 percent of current expenditures, about double the current level, according to a new study.
The report, "When It Rains, It Pours," by the Center on Budget and Policy Priorities, is the first-ever to examine the fiscal health of 48 state governments, including their "rainy day"or reserve funds, against the backdrop of a possible recession. The study found that only eight states Delaware, Indiana, Iowa, Maine, Massachusetts, Michigan, Minnesota and North Dakota could bridge the gaps between revenues and expenditures that could accompany a downturn of the same length and severity as the recession of the early 1990s.
Meanwhile, in 11 states available reserves fall short of what would be needed by amounts equivalent to more than 20 percent of fiscal year 1999 expenditures: Idaho (33 percent), Oregon (29 percent), Texas (29 percent), West Virginia (28 percent), Wisconsin (25 percent), Tennessee (25 percent), South Dakota (25 percent), Nevada (23 percent), Utah (23 percent), New Hampshire (22 percent) and Georgia (21 percent).
Overall, at the end of state fiscal year 1999, state budgetary reserves are expected to fall $51 billion short of the $80 billion that would be needed entering another recession to maintain programs and services without raising taxes.
The report examines a hypothetical recession that begins in the middle of calendar year 2000 and assumes that states experience fiscal stress for the subsequent three years, parallel to the experience in the relatively mild recession of the early 1990s. It was prepared using data from the National Association of State Budget Officers, the National Conference of State Legislatures (NCSL) and state fiscal offices, and excludes Alaska, where general fund revenues come largely from the petroleum industry. Hawaii was also not considered because its economic health is affected by the condition of East Asian economies and heavy reliance on tourism revenues.
"Financial woes abroad should be a reminder that another U.S. recession is possible and even probable in the next few years," said Iris Lav, the Center's Deputy Director and a coauthor of the report. "Nobody is hoping for another recession, but it's only prudent to ask whether states have done enough to prepare for the next one."
The report notes that the fiscal structures of state governments, including requirements that state budgets be balanced each year or biennium, pose particular problems during economic recessions. As a state's economy enters a downturn, falling employment slows growth in state revenues, while rising poverty and unemployment increase the demand for state expenditures. Together, these effects create large budget deficits, which in turn force large tax increases or spending cuts at a time when residents are least able to deal with such measures.
"Although the last recession was considered relatively mild and officially lasted only nine months at the national level, many states faced fiscal shortfalls beginning in 1989 and continuing into 1992," said Alan Berube, a Center researcher and coauthor of the study. "While state reserve balances totaled 4.7 percent of expenditures when the recession of the early 1990s began, no fewer than 35 states faced a potential budget deficit at one point from 1990 to 1992, and many faced problems throughout the period."
To cope with the shortfalls of the early 1990s, states approved record tax increases and cut expenditures and services sharply. Programs for low-income households were particularly hard hit by reductions.
How Much Reserve is Enough?
The insufficient reserve levels held by states when the recession hit in 1990 may have been in part a product of a rule-of-thumb state-savings benchmark of "uncertain origin and even more questionable validity," the report notes.
After the fiscal downturns of the 1980s, many states established budget stabilization or "rainy day" funds designed to receive surplus revenues when a state's finances were healthy against a future slump. Currently 45 states have such a fund. The target level for those rainy day funds has typically been five percent of annual general fund expenditures, a figure widely held to be based on recommendations from NCSL and Wall Street analysts.
In fact, the five percent recommendation was intended to serve as guideline for reserves against normal contingencies, such as errors in forecasting revenues or unexpected outlays like settlement of a lawsuit. In a 1983 report, an NCSL committee suggested that a five-percent reserve level was "useful only when the economic weather forecast is 'overcast with a mild drizzle' rather than 'continued thunderstorms with flooding expected.'"
As noted, the reserves equaling 4.7 percent of expenditures that states held at the beginning of the last recession did little to ward off widespread fiscal crisis and distress. In the future recession projected in this report, a five percent reserve would be sufficient in only three states.
Hypothetical Recession: FY 2001-2003
Shortfall in Reserves
|More than 20%||15% to 20%||10% to 15%||0% to 10%||No Shortfall|
|More than 25%||Idaho
South Dakota Tennessee
|20% to 25%||Georgia
|15% to 20%||Arkansas||Arizona
|10% to 15%||Alabama||New Jersey
As states consider their budgets for fiscal year 1999, there are important choices to be made about the amount of funds that will be held in reserve and about the disposition of "surplus" funds that are not saved for future contingencies. Among the report's recommendations:
- Proposals for new tax cuts or accelerating the phase-in of previously enacted tax cuts should be considered in light of how the tax reductions would affect their ability to provide current programs and services over the next several years, under both favorable and adverse economic conditions.
- Some 45 states have budget stabilization or "rainy day funds, " but not all have made adequate deposits to them. States should consider using the opportunity of healthy revenues to further shore up their funds. The states that lack stabilization funds should consider creating them.
- Since 1993, general fund expenditures have declined as a percentage of personal income in about 20 states. States with substantial declines include Maine, Massachusetts, Michigan, Nevada, New Jersey, New York, North Dakota, and Washington. Such declines suggest that state services may not be keeping pace with the needs of the population. States with declining expenditure levels should consider devoting some of their surpluses to improving public investments and services.
- States that used a variety of fiscal gimmicks in the last recession, such as delaying tax refunds or payments to vendors, should use a portion of their surpluses to restore more standard fiscal practices. States that changed state-local funding relationships during the last recession should reassess whether those relationships are still appropriate.
When It Rains, It Pours
Michigan League for Human Services
AR Advocates for Children & Families
Minnesota Budget Project
Children's Action Alliance
Fiscal Policy Institute
California Budget Project
North Carolina Budget & Tax Center
Colorado Budget Project
Oregon Center for Public Policy
Kentucky Youth Advocates
Tennessee Budget Project
Christopher St. John
Maine Center for Economic Policy
Center on Wisconsin Strategy
Maryland Budget & Tax Policy Institute
WI Council on Children & Families
Jim St. George
Commonwealth Center for Fiscal Policy