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Surpluses Help, but Fiscal Woes for States Go On

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While the fiscal picture is brightening around the country, with many states expecting surpluses this year after years of deficits and wrenching budget crises, mounting Medicaid costs and underfunded retirement promises are continuing to cloud their long-term outlook.

And some of the surpluses that are materializing, as welcome as they are, are not as robust as they appear at first glance — especially as bills come due for some of the costs that states put off during the long economic downturn.

When Texas lawmakers went into session in January, they were met with some good news: the state was projecting an $8.8 billion surplus when its two-year budget cycle ends in August. But it turned out that much of that extra money was already spoken for: more than half of it had to be used to pay Medicaid costs the state had delayed paying earlier.

And Texas, like many states, has not been fully funding its pensions. Last year the state contributed just 49.2 percent of what actuaries said was needed by the state workers' pension fund. Eventually the remaining money, around $358 million, will still have to be put into the fund, along with the 8 percent investment return the fund is supposed to earn each year.

In Hawaii, Gov. Neil Abercrombie, a Democrat, recently opened his re-election campaign by noting that the $200 million deficit he inherited upon taking office has been transformed into a positive balance of $300 million. But Hawaii faces enormous looming bills: its pension system currently has less than 60 cents of every dollar it has promised retirees, and it is more than $13 billion short of what it will need to pay for the health coverage it has promised its retired workers.

And California, which faced a $26 billion deficit two years ago, expects a surplus of between $1.2 billion and $4.4 billion this year, thanks to a combination of tax increases, budget cuts and an improving economy. But it could be erased if the state were to adequately finance its teachers' pension fund, which says it will need an additional $4.5 billion a year, much of it from the state, to pay the benefits it promised.

"The problems are still there," said Richard Ravitch, a former lieutenant governor of New York who formed a State Budget Crisis Task Force last year to focus attention on the long-term problems facing states. "It's retirement expenses, generally, and health care expenses — and they're crowding out other things."

Of course, surpluses are better than deficits. When the fiscal crisis hit states full force in 2009, 41 states were forced to make disruptive midyear budget cuts, according to a survey by the National Governors Association and the National Association of State Budget Officers. This year, only a handful did — and most states are expected to end the year with surpluses, or with money to replenish their depleted rainy-day funds.

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But many challenges loom, as they have since before the recession. A 2007 study by the Government Accountability Office was titled "State and Local Governments: Persistent Fiscal Challenges Will Likely Emerge Within the Next Decade." This spring the office warned that the continuing near-term and long-term state and local government challenges "add to the nation's overall challenges," noting that the problem was largely driven by rising health care costs.

And some states are still in considerable fiscal distress. Illinois, which still faces large backlogs of unpaid bills, the weakest pension system of any state and the lowest credit rating of any state, failed to approve an overhaul of its pension system this week. As time was running out in its state legislative session, some leaders in the Democrat-controlled Capitol were pleading for a last-ditch plan to address the state's pension crisis. The system was in bad shape even before the financial crisis of 2008 struck, and now it requires an ever-bigger slice of the state budget every year to meet its promises.

Donald J. Boyd, a senior fellow at the Nelson A. Rockefeller Institute of Government, in Albany, said states still face enormous costs to pay for the obligations they have made. "I know a lot of people are pinning their hopes and mantras on the idea that an improved stock market will bail pension funds out, but it will take so much more than we have seen — and the risk to governments, if it goes wrong, is frightening," he said.

In some states the surpluses may reflect an improving economy, but in many they are the result of the tough steps taken during the downturn, which included making deep cuts to services; furloughing, laying off and reducing the benefits of workers; delaying repairs to roads and bridges; and raising taxes.

To some extent, said Scott D. Pattison, the executive director of the budget officers' group, the current surpluses are a reflection of the way that the states' annual revenue forecasts grew more conservative during the downturn and slow recovery. "It's more a function of there being more money than they thought there would be," he said, "and not a signal that their financial challenges are over."

Now the surpluses have spurred debate in statehouses around the county, with some officials seeking to restore services and rehire workers, and others pushing new tax cuts. Governors from both parties, though, find themselves urging restraint as their states climb back from the recession.

Barry Anderson, the deputy director of the National Governors Association, used a homespun analogy for the situation that many states find themselves in. "I can see Mom and Dad at the kitchen table," he said, "saying: 'Wow, we did a little better than we anticipated here — but let's not go out and blow it all, let's set it aside. Because we know, not only do we need a new car, or to take care of the leaks in the basement, but Johnny and Joanie are going to need insurance coverage.' "

Rising health care costs continue to pose one of the biggest challenges to states, and the trend has many governors concerned.

Although the rate of Medicaid cost increases has slowed, Mr. Anderson said, those costs have continued to rise — and enrollments have risen as well, driving up expenses for many states. Medicaid was the biggest single component of total state spending this year, the most recent survey of states found: states were planning to spend 23.9 percent of their money on Medicaid — more than the 19.8 percent they were planning to spend on primary and secondary education, and more than what they planned to spend on higher education and transportation combined. Many states put off needed road maintenance during the downturn.

There are other threats on the horizon as well. Both Mr. Anderson and Mr. Pattison cautioned that some of the better-than-expected tax collections that many states experienced this year could be a one-time fluke: a higher-than-usual number of taxpayers apparently sold investments at the end of 2012 as Congress debated what to do about the so-called fiscal cliff, fearing the prospect of higher tax rates.

"We're advising states to consider identifying money that is the result of one-time-only activity," Mr. Pattison said, "and then try to avoid putting that into ongoing operating expenses."

Monica Davey contributed reporting.

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