Revised April 26, 2004

By Elizabeth McNichol and Makeda Harris

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State government continues to shrink as states struggle to deal with the lingering state fiscal crisis.  States cut expenditures over the last three years as they filled budget gaps that totaled about $250 billion.  Despite the turnaround in the national economy, many states continue to face gaps in their fiscal year 2005 budgets.  States remain reluctant to raise taxes and are running out of short-term fixes; they are once again turning to spending cuts to close those gaps.

Figure 1 shows total state spending as a percent of Gross Domestic Product — a widely used measure of the size of the country’s economy.  (See Appendix for information on the methodology used and data sources.)  State spending as a share of the economy remained fairly steady between 1990 and 2000, averaging 4.85 percent of GDP.  In fiscal year 2001, state spending as a share of the economy grew as the softening of the economy had a delayed impact on state revenues and budgets. Since then, state spending has declined significantly.  This year — fiscal year 2004 – spending totals 4.60 percent of GDP – well below the level of FY1990 and below the level to which spending dropped in the depths of the recession the early 1990s.   Current indications are that this decline will continue in fiscal year 2005.

Figure 1

State Budget Cuts

The decline in expenditures continues to put important government services at risk in many states.  Many states are considering or have adopted budget cuts for fiscal year 2005.  These cuts would come on top of the widespread budget cuts adopted over the last few years.  (See box below.)

More detail on fiscal year 2005 cuts in these and other areas is provided later in this paper.

Proposed Fiscal Year 2005 Budget Cuts Would Be In Addition to
Widespread Cuts of Recent Years

Some 34 states have adopted cuts that are causing 1.2 to 1.6 million low-income people to lose health insurance.  Most of the cuts have affected children and parents in families in which the parents work at low-wage jobs.  For example, Texas will end coverage under the Children's Health Insurance Program for nearly 160,000 children in working families, and Connecticut reduced Medicaid eligibility for parents with incomes from 100 to 150 percent of poverty, with about 20,500 parents affected.  Six states — Alabama, Colorado, Florida, Maryland, Montana and Utah — have stopped enrolling eligible children in their State Children’s Health Insurance Program (SCHIP.)  New or higher copayments for public health insurance services were imposed by 21 states for fiscal year 2004; the previous year 17 states added or increased copayments. Research has shown that copayments are a significant deterrent to the use of essential medical care and prescription drugs among low-income populations, and that there are adverse health consequences when such treatment is foregone or delayed.

Since January 2001, some 23 states have made policy changes that reduce the availability of child care subsidies for low-income working families.  In about half the states, low-income families who are eligible for and need child care assistance are either not allowed to apply or are placed on a waiting list.  As of December 2003, there were some 47,000 children on the child care waiting list in Florida.  Tennessee no longer even accepts child care applications from families that do not receive TANF cash assistance.  In many cases, a child care subsidy is necessary to make it possible for a parent to work.

While states usually show great reluctance to cut K-12 education, 11 states made cuts for fiscal year 2004, following 9 that did so the previous year.  In 34 states, real per-pupil aid to school districts has declined since 2002; in 19 states the decline exceeds 5 percent.  This has resulted in imposition of new or higher fees for textbooks and courses, shorter school days, reduced personnel, reduced transportation, and a variety of other types of cutbacks.  And states throughout the country are cutting higher education, leading to double digit increases in public college and university tuition and significantly reduced course offerings, creating barriers to a higher education for low- and moderate-income families.


State Taxes are Declining

State budgets are shrinking because state tax collections were hard hit by the economic downturn.  State tax revenues declined relative to the same quarter of the prior year for eight straight quarters — two complete fiscal years — according to data collected from state revenue departments by the Nelson A. Rockefeller Institute of Government which is adjusted for inflation and tax law changes.  (See Figure 2.)  Real per capita state tax revenue remains far below the levels of 2001.

Figure 2

State tax revenue did begin to grow at the end of 2003.  According to the most recent data collected by the Rockefeller Institute, state tax revenue grew by 1.8 percent in the October to December 2003 quarter compared to a year ago, after adjusting for inflation and tax law changes.  While this return to growth in real underlying state tax revenues is welcome, it would be premature to declare the end of the state fiscal crunch.

Why Are State Taxes Declining?

One reason for the revenue decline is the economic downturn.  The sales tax and the income tax are the main sources of state tax revenue.  The job losses of the recession and continued weak economy resulted in reduced incomes for families and reduced spending which, in turn, depressed sales tax collections.  The decline in incomes had a direct effect on state income tax collections.  In addition, most states tax the realization of capital gains and the decline in income tax revenues was particularly pronounced because of the dramatic stock market decline that accompanied the recession.

Another reason for the revenue decline is the ongoing erosion of state tax bases.  Sales tax collections make up about one-third of state tax revenues.  Most states mainly tax the consumption of goods, not services.  Sales tax collections have lagged economic growth as untaxed services have become an increasing portion of overall economic activity.

The tax cuts of the 1990s also played a role in reducing state revenues.  Despite the fact that the surge in revenues in the 1990s was temporary, many states enacted permanent tax cuts with the resulting surpluses.  As a result, state revenues have not been sufficient to sustain services now that the economy has slowed.  Since 2001, some 29 states have responded by raising taxes, but these tax increases have not been large enough to offset the earlier cuts.


State Budget Cuts for Fiscal Year 2005

The sections below summarize some of the budget cuts adopted or being considered by the states as they adopt fiscal year 2005 budgets.  These examples are drawn from a number of sources including press accounts and budget summaries published by state-based non-profit policy organizations.  To the extent possible the cuts listed were checked with additional sources.  Because many state legislatures are still in the process of budget deliberations, the specific proposals cited below are subject to change.  This list is not meant to be comprehensive but rather gives examples of the kinds of spending cuts that states are considering.


Health Care

A large number of people are becoming uninsured as a result of the fiscal crisis.  Budget cuts enacted since the fiscal crisis began have eliminated Medicaid or State Children’s Health Insurance Program (SCHIP) coverage for more than one million people nationwide.  Health care services for low-income families continue to face cutbacks this year.


K-12 Education

The amount of state education aid to school districts included in proposed fiscal year 2005 budgets in the following states falls short of the amount needed to maintain current services or restore cuts made over the last few years: California, Georgia, Maryland, Massachusetts, Michigan, Mississippi, New York, Oklahoma, and Oregon.   These reductions can result in teacher and staff cutbacks or increased property taxes as schools seek to replace state funds. 


Higher Education

State funds for public universities or colleges will be reduced or held to a level that will require tuition increases or service reductions in budgets in California, Maine, Maryland, Massachusetts, and Texas. 


Child Care

States subsidize child care for low-income families through subsidies to providers or assistance to families with child care costs.  Over the past several years, many states made cuts in their child care programs.  These included reducing the eligibility criteria for child care subsidy programs, cutting payments to providers, and increasing the co-payments made by low-income families who receive child care subsidies.  More than half of all states now have waiting lists for their child care subsidy programs or do not accept new applications at all from non-welfare families seeking help paying for child care.  For example, more than 280,000 children on are waiting lists in California alone.

Florida, Massachusetts, and Rhode Island are proposing cuts in child care programs in their FY 2005 budgets.


Income Support  Programs

Funding for income support and other TANF-funded programs would be reduced in budgets in California, Louisiana, Massachusetts, New York, and Rhode Island.


Other Social Services

In addition to cash assistance and subsidized child care states fund a variety of social service programs such as food assistance, programs for the mentally ill, homeless shelters, programs for the disabled and foster care programs either directly or through grants to non-profit agencies.  Proposed budgets include cuts in social service programs in Arizona, California, Illinois, Kansas, Louisiana, and Massachusetts.


Courts, Corrections, and Public Safety

States run prison systems and courts and provide funding to local governments to support juvenile justice systems and local courts and prisons.  States have faced increasing costs in these areas in recent years and some states have turned to cutbacks.


Aid to Localities

One way states can meet their balanced budget requirements is by cutting aid to local governments rather than cutting programs directly funded by the state.  Reductions in aid to localities usually lead to cuts in services and programs such as social services or public safety that local governments provide.  Alternatively, such cuts may lead to local property tax increases.  Proposed budgets in California, Connecticut, Maryland, Massachusetts, Michigan, and New York contain reductions in aid to local governments.


State Employment

State jobs and state employee pensions and health benefits have been targets for cutbacks.

Methodology for Figure 1
State Spending as a Percent of Gross Domestic Product

 Data Sources 

The state spending data in this paper for fiscal years 2002 and earlier were published by the National Association of State Budget Officers in their annual Fiscal Survey of the States.  The figures for fiscal years 2003 through 2005 were compiled by the State Fiscal Project staff of the Center on Budget and Policy Priorities.  The data were in published budget documents or supplied by legislative or administration budget officials through a phone survey.

Use of General Fund Spending

The information presented is on general fund spending.  All states maintain other funds in addition to the general fund.  The other funds are used to account for spending from specific revenue sources such as federal funds or tobacco settlement revenues, or to account for spending on specific purposes such as state employee pensions or transportation projects that are supported by dedicated taxes or bonds.  State general fund spending makes up about half of total state spending on average.  Trends in general fund spending are particularly important to tracking and understanding state finances for a number of reasons.

Occasionally, a state will put revenues or expenditures in a special fund that more appropriately belong in the general fund.  For example, New Jersey places its income tax collections in a fund that is used for aid to local governments.  Both this revenue source and spending would be in the general fund in most states.  In most cases, if the state treats this type of special fund as an add-on to the general fund in its budget deliberations and published budget documents, we and the other two organizations that track general fund spending — the National Conference of State Legislatures and the National Association of State Budget Officers — treat the sum of spending from these funds and the general fund as general fund spending.  Other situations where a special fund exists that should be part of the general fund are not sufficiently frequent or large as to suggest that analysis of general fund spending trends materially distorts the picture of state spending.

Spending figures are shown as a percent of Gross Domestic Product.  The GDP figures for 2003 and earlier are from the Bureau of Economic Analysis.  The Congressional Budget Office GDP projections were used for 2004 and 2005.

Why Spending is Shown as a Percent of Gross Domestic Product

While state spending changes from year to year often are compared using nominal dollars, such comparisons do not accurately measure the ability of states to continue providing their current level of services.  That ability is steadily eroded both by inflation (which increases the number of dollars needed to provide a given service to a given individual) and by population growth.  Population growth — especially growth in specific expensive-to-serve populations such as school-age children and the elderly — increases the number of individuals who are eligible for programs and services or who otherwise must be served.

Thus, the appropriate measure of changes in state spending is one that assesses whether a given state can continue to provide existing services.  The simplest way to look at the buying power of state dollars is to adjust spending for overall inflation and total population changes, as is often done.  However, inflation plus population is only a partial adjustment for the true cost of providing a constant level of public services.  It also is conceptually possible but difficult in practice to adjust more precisely for buying power by using specific inflation rates — for expenditures such as healthcare, since a large proportion of state spending goes for health care and health care inflation has been much more rapid than general inflation — or to adjust for growth in specific population segments relative to the services that must be provided to those population groups.  One proxy for this type of adjustment is to look at state spending relative to the size of the economy.  Figure 1 shows state spending as a percent of Gross Domestic Product — a widely used measure of the size of the country’s economy.

End Notes:

[1] See, for example, Sources of Data About State Government Revenues and Expenditures, David Merriman, Urban Institute, 2000; “Receipts and Expenditures of State Governments and Local Governments,” 1959-2001; Survey of Current Business, Bureau of Economic Analysis, June 2003.