Three States Act As Guinea Pigs In Budget Turmoil

January 2011

The federal deficit’s unsustainable levels have received significant media attention. Less attention has been paid to similar large problems the states face. However, almost every state (46 to be exact) struggled to close budget shortfalls for the current fiscal year (which begins July 1 in most states). A policy analyst at the Center for Budget and Policy Priorities says that states will have to undertake a number of measures to bring their budgets out of the red; specifically,

"States are facing a very significant fiscal problem. The problem states are facing is really too big for any single solution."

Those “solutions” usually include some combination of remedies like raising taxes, cutting spending, and drawing on reserves, all of which are risky and affect the competitiveness of the state vs. other locations. An obvious risk includes lower investment ratings. Illinois and California are rated A1 by Moody’s, the fifth highest investment grade and the lowest level for any state’s general-obligation debt. Standard & Poor’s rates Illinois at A+, its fifth highest grade; California is rated less with an A, four steps above junk status. In September 2010, Moody’s forecast possible “further financial deterioration” in Illinois, citing budget issues.

Some of this is caused by state employee pensions, which we previously analyzed.

The table below quickly shows why California and Illinois have such low ratings. The following table lists the 10 states that are projecting the largest shortfalls for fiscal year (“FY”) 2012:

When viewed as a percentage of the full state budget, the challenge of closing these budget gaps appears even more overpowering. Illinois’ $17 billion 2012 shortfall is more than half the size of the 2011 state budget. In total, 40 states project shortfalls for their 2012 budgets. The following table lists the 10 states with the largest 2012 projected shortfalls relative to their most recent budget.  

To tackle their projected 2012 state budget deficit, California, Illinois, and New York provide other deficit states three distinctively different models for what works and what doesn’t work.

California

Newly-elected Governor Jerry Brown proposed a budget last week that utilized approximately equal amounts of spending cuts and increased taxes. A prerequisite for Governor Brown’s proposed increased taxes is a special election to be held in June, in which voters will be asked to extend for five years (through 2016) tax hikes enacted in 2009. The additional taxes are income taxes, sales taxes, and vehicle registration taxes. California’s dire situation probably explains Governor Brown's amnesia regarding what happened the last time voters received this proposal. In the May 2009 special election, 65 percent of California voters rejected Proposition 1A, which (like Governor Brown’s current proposal) temporarily would have extended these tax increases.

Brown’s proposed spending cuts include:

1. $1.5 billion from welfare

2. $1.7 billion from Medi-Cal

3. $500 million each from the University of California and California State University systems

4. $750 million from services for the developmentally disabled

5. $200 million from the state bureaucracy.

Illinois

Last week, in the last hours of their term, lawmakers passed a 67 percent income tax increase, the largest in the state’s history. No spending cuts were passed. The income tax increase from 3 percent to 5 percent is intended to last through 2014. However, if it is anything like California, Illinois residents best get used to the possibility that the “temporary” tax increase will become permanent. The increase is aimed at fixing Illinois’s worst fiscal crisis, including a backlog of more than $6 billion in unpaid bills and almost $4 billion in missed payments to underfunded state pensions.

New York

Newly-elected Governor Andrew Cuomo plans spending freezes and no tax increases. Cuomo is expected to announce a one-year pay freeze for state workers during his first State of the State address. A spokesman for NY state budget division said that Cuomo does not plan to raise taxes to try and fill the gap

"because right now we are the tax capital of America, if you combine state and federal taxes."

Assuming these three distinct state budget deficit experimental “solutions” go forward, the results will provide other deficit-plagued states with a real life experiment in possible solutions.

Fulcrum Inquiry performs economic analysis and forensic accounting services.