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US states dig out of huge budget hole, but it's only a start

U.S. states are spending at a level the nation has not seen in a long time. But don't fear that loose pockets are reigning again in state capitols. And don't give governors and state budget managers too much credit for digging out of deep budget holes.

A Deere & Co. 210G excavator is used to dig the foundation for a new home in Dunlap, Illinois
Daniel Acker | Bloomberg | Getty Images

U.S. states as a whole have reached the prerecession annual general fund-spending growth level of 5.5 percent, according to an analysis from the National Association of State Budget Officers (NASBO). State fiscal experts say hitting this crucial prerecession mark is notable, but it can also be viewed through a less-impressive lens: It took seven years for the states to get back to budgetary square one. The 5.5 percent mark is also the long-term historical average for state annual spending growth.

"That's a really long time to get back to a prerecession level," said Michael Leachman, director of state fiscal research with the Center on Budget and Policy Priorities, adding that "5.5 percent is a positive thing; it's just not getting the states where they need to be."

Digging into the real growth rate

"It's positive news, but with caveats," said Brian Sigritz, director of state fiscal studies at NASBO.

Here are a few:

A majority of individual states (29) have yet to surpass their fiscal 2008 spending levels adjusted for inflation, while revenue totals in 23 states remain below fiscal 2008 levels.

The median spending growth level — which removes the impact of states with more extreme performance that contribute to the 5.5 percent spending growth — was 3.8 percent in 2016.

It's also important to note that all the budget cutting that has taken place since the recession helped states to finally hit the 5.5 percent spending growth mark. "They cut, and that's why it's easier to get to 5.5 percent," said Lucy Dadayan, senior policy analyst at the Rockefeller Institute of Government.

And the states may not even stay at this budgetary square one for long; the average spending growth is projected to fall back from 5.5 percent to 2.5 percent in fiscal 2017, less than half this year's accomplishment and based on governors' recommended budgets and governors' forecasts for revenue growth of 2.9 percent in 2017.

The revenue growth coming out of this recession versus previous recessions show a much different path, Leachman said. "The drop was much greater, and the recovery line is taking much longer to get back to zero."

"The bigger picture at the moment, unless we're headed into a recession, is gradual growth after a very big decline. And what that really means for state budgets, getting back to zero when adjusted for inflation, isn't really a recovery," Leachman said. "They have hundreds of thousands of more K–12 kids to educate and many more students in universities," he said, adding, "The slowing rate of growth is definitely something to be concerned about."

"The slowing rate of growth is definitely something to be concerned about." -Michael Leachman, director of state fiscal research, Center on Budget and Policy Priorities

Another way to look at the state of the state budgets is through the rating agencies. Standard & Poor's has eight states on Negative Outlook and two states it rates at CreditWatch Negative. "It's unusual at this stage of an economic recovery to have 20 percent of the state sector on negative watch," said Gabe Petek, managing director in the U.S. states division of the S&P U.S. public finance department.

Based on the latest state GDP data from the U.S. Census Bureau (which goes through the fourth quarter of 2015), 28 of the 50 states showed a decline in GDP growth from the previous year. Two states showed flat growth year over year. "For 30 states to be flat or slower growth is just another indicator that it's a listless recovery," Petek said.

John Hicks, executive director of NASBO, had previously been the deputy state budget director in Kentucky.

"It's one of the states that has large unfunded pension liabilities," Hicks said. "The governor there just passed a budget, got out the checkbook and started a financial plan to resolve the unfunded liability. But in states like that there is no way to fix quickly; it's not even a possibility," Hicks said. "States are getting serious about some options even in a slow-growth economic situation," he said.

Pension funding is the most high profile on a long list of funding issues across the state landscape that have attracted attention in recent years as the states attempted to crawl out of budgetary holes — a list that also includes infrastructure, education and health care. And the acute issues in energy-dependent states have been a major drag.

State budget experts are concerned beyond the 2016 uptick in growth because what they see are structural problems in state revenue systems that are gradually eroding the ability of states to raise the revenue they need. Declining ability to generate consistent income-tax revenue gains — which tend to fluctuate based on stock market performance rather than responding to a stronger employment trend — and broad declines in sales-tax revenue in a world that is no longer built around goods but now favors services.

NASBO's Sigritz said absent additional tax policy changes, the expectation is continued slowing growth on the revenue side of the state fiscal equation. But 25 states were able to increase rainy-day fund balances in fiscal 2016, and 27 states proposed increases in fiscal 2017. Only six states projected a decline, according to NASBO.

"The numbers show that states are balancing budgets against limited revenue growth and we don't see big outliers, with the exception of energy states," Hicks said. "North Dakota, for example, has used a lot of its rainy-day fund and were not expecting things to get back to where they were even if oil goes up," Hicks said. "They will have to make significant cuts."

"It's growth in most states, and that's positive," Dadayan said. "States are finally spending more on K–12. But for sure, the states are not out of the woods. We have been tracking state forecasts and have been devising growth downward in recent months for fiscal 2017."