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The State Budget Crisis Task Force weighs in

Much as the Simpson-Bowles report aspired to be the foremost guide to reducing the federal deficit, the Volcker-Ravitch report on the state budget crisis that was released yesterday hopes to serve a similar purpose for state government spending. Paul Volcker, the former Fed chairman, and Richard Ravitch, who helped New York City work itself out of bankruptcy, led the State Budget Crisis Task Force, the group that produced this report. The task force also included two former U.S. Treasury Secretaries as members. The bottom line of the report is that there is less money to go around and that states should become better managers of the shrinking economic pie:

The United States Constitution leaves to states the responsibility for most domestic governmental functions: states and their localities largely finance and build public infrastructure, educate our children, maintain public safety, and implement the social safety net. State and local governments spend $2.5 trillion annually and employ over 19 million workers – 15 percent of the national total and 6 times as many workers as the federal government…

…States are grappling with unprecedented fiscal crises. Even before the 2008 financial collapse, many states faced long-term structural problems. Many economists believe that in the aftermath of the crisis, the economy will grow sluggishly for years as it works off the excesses of the credit and real estate bubbles and endures slow employment growth. Tax revenues are recovering slowly and remain well below their pre-crisis trends.

Basically states, once flush with revenues, have overpromised benefits to their retirees, set aside too little in reserves to cover their liabilities, mismanaged their books and sat idly by while their tax base eroded as a result of changes in consumer behavior. The two big issues for state budgets are public pensions and Medicaid, both of which are somewhat out of the states’ control. Although states assume about half the cost of Medicaid, decisions about the program are made at the federal level. States must apply to Washington for an exemption to make changes to their program. Pension benefits are enshrined in contracts and are generally governed by a state’s constitution. Making changes to pensions, outside of bankruptcy, is either impossible or would require constitutional amendments.

The report is a landmark for recognizing that the decades-long expansion of state and local governments must come to an end. Harsh economic conditions have collided with gross structural imbalances, and the report highlights the dimensions of the wreckage.

Dark clouds in the Golden State

In a YouTube address released last Friday, California Governor Jerry Brown shocked his constituents with an announcement that the state’s projected revenue shortfall had increased to $16 billion. This followed very weak April state income tax collections, which deepened the budget hole from the $9 billion that Brown had originally forecast in January. The new deficit is a result of a reduced revenue outlook for California, higher school funding costs, and decisions by the federal government and courts to block certain budget cuts. New cuts that Brown floated yesterday will reduce General Fund spending as a share of California’s economy to its lowest level since 1972‑73.

The $92 billion budget that Brown had proposed in January for the fiscal year 2012-2013 (which starts on July 1) looked like this:

With the new revenue shortfall, almost every area of the state budget has been targeted for cuts; education, which accounts for 53 percent of General Fund spending, is the only category that was spared. In his revised proposal, Brown substantially increased K‑14 spending (i.e., includes two years of community college or vocational training) and protected the University of California and California State University from further, deeper cuts. School spending is mandated by Proposition 98, which requires that California pass through a substantial portion of state revenues to local governments to fund education.

Overall, Brown proposed that half of the budget hole should be plugged with spending cuts, 35 percent with tax hikes and 15 percent with financial gimmicks. Brown’s preferred budget cuts (pages 5-7) total $8.3 billion and include a $1.2 billion reduction to California’s medicaid program (Medi-Cal), an $880 million reduction to welfare (Temporary Assistance to Needy Families payments) and a 7 percent reduction in hours to in-home supportive-care-services providers.

The soft side of federal spending

It’s not clear that Congress is capable of doing its job of managing the nation’s purse strings. Capitol Hill failed at identifying a combination of tax increases and reductions in spending that would have lowered our growing debt burden. Now every constituency that draws funds from the U.S. Treasury is angling to push others away from the trough. A perfect example is the internecine warfare to come over defense cuts. Here is a slick ad against funding for the military’s nuclear arsernal obviously coming from the traditional munitions and equipment makers:

The military players are well versed at battling over the spoils. But it’s the soft side of federal spending, where social support and services are funded, that is less equipped to fight over its share of decreased funding.

The automatic cuts that kick in due to the failure of the supercommittee are aimed at defense, Medicare and Social Security, and other discretionary social programs. The legislation spares cuts for Medicaid payments to states. It’s interesting that this area was protected when other major areas of the budget will have reductions. Medicaid cuts were the reductions that governors and county officials feared most because they consume an increasing amount of state and local budgets. Maybe governors were the real winners of the lobbying game when the Budget Control Act of 2011 was being written.

Illinois’s crack habit

The state of Illinois has been riding the easy governance boat on a river of debt. It has run up its borrowing to fund infrastructure, pension liabilities and unpaid bills. According to state treasurer Dan Rutherford, Illinois’s debt load currently amounts to $198 billion — that is a mountain of debt. The amount is also about 31% of the 2009 gross state product of $630 billion.You get the feeling that Illinois state government is addicted to overspending and debt and just can’t let go of that overdraft account down at the bank.

Reuters describes the fiscal situation:

Even with a big income tax rate hike passed in January, Illinois is still spending about $5 billion more a year than it receives in revenue, according to the position paper, which also said the state’s low bond ratings have resulted in higher borrowing costs compared with other states.

Governor Pat Quinn has been pushing the legislature for anywhere from $2 billion to $8.75 billion of bond authority to pay off bills and other obligations incurred this fiscal year.

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