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S&P Agrees: A Balanced Approach Is the Right Way to Tackle State Shortfalls

With unemployment still high and revenues still 11 percent below pre-recession levels, states must close over $125 billion in shortfalls as they enact their budgets for fiscal year 2012, which begins July 1 in most states.  The critical question is this:  will they do so through spending cuts alone or through a more balanced approach that includes a mix of strategies, including higher revenues?

Let’s first look at Texas, which faces shortfalls averaging $13.4 billion a year over the next two years.  My colleague Phil Oliff pointed out last month that the legislative leadership’s cuts-only proposal would not only hurt children, college students, seniors, and others, but also weaken the state’s economy by reducing overall demand.

The credit ratings agency Standard & Poor’s recommends that Texas instead adopt “a balanced approach that includes both revenue enhancements and expenditure cuts.”  In a February 16 report, S&P analyst Horacio Aldrete-Sanchez writes that a balanced approach has “a higher potential of success in preserving the state’s long-term structural budget balance than a strategy that relies solely on expenditure cutbacks.”

Another S&P analyst, Gabriel Petek, also recently advised against a cuts-only approach:  “States like Texas, Nevada, Washington and Idaho have governors who have made it adamantly clear they’re not pursuing any kind of tax increases. . . .  [E]liminating one of the main policy options off the bat before negotiations even begin is a little like a boxer tying one hand behind his back.”

While policymakers’ first response to a shortfall is often an across-the-board spending reduction, closing the entire shortfall with budget cuts would threaten the people and businesses that use state services and could create a significant drag on the economy.

Two new CBPP reports show why a balanced approach makes more sense:

  • Michael Leachman, Erica Williams, and I looked at 41 states’ initial budget proposals for fiscal year 2012.  Governors in many states are proposing deep cuts in primary and secondary education (at least 16 states), health care (at least 23), colleges and universities (at least 15), and the state workforce (at least 14).   And governors in Florida, New Jersey, and some other states are proposing new tax cuts, which would have to be financed through even bigger cuts in public services.On the other hand, a slightly larger group of governors — like those in Connecticut, Hawaii, and Minnesota — propose replacing some of the revenues lost due to the recession by increasing tax rates, closing corporate tax loopholes, and other measures.  Those governors are still proposing cutting services, but not as deeply as they otherwise would have to.
  • Iris Lav and Dylan Grundman explained that states have a range of policies to close budget shortfalls while maintaining important services.  The report outlines seven components of a balanced approach to dealing with state shortfalls:

1.      Efficiency – focusing on the goals of spending and whether there are better ways to reach those goals, such as by reducing the number of people in state prisons and being smarter about economic development incentives;

2.      Using all available resources — using reserves and rainy day funds responsibly and wisely;

3.      Scrutinizing all spending, not just what is appropriated through the budget — including spending made in the form of tax breaks;

4.      Improved collections — aggressively seeking taxes due that are not being paid;

5.      Tax increases — raising taxes, particularly when it would have a more positive impact on the economy than spending cuts;

6.      Prioritization — making careful decisions based on goals and effectiveness when budgets must be cut; and

7.      Paying close attention to future impact while fixing today’s problems.

The budget problems triggered by the recession are too big for any single solution.  States should use every tool they’ve got to address this crisis.