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Gloomy Forecast for States, Even If Economy Rebounds

The fiscal crisis for states will persist long after the economy rebounds as they confront rising health care costs, underfunded pensions, ignored infrastructure needs, eroding revenues and expected federal budget cuts, according to a report issued here Tuesday by a task force of respected budget experts.

The Capitol Building in Washington, D.C.
Robert Clare | Taxi | Getty Images
The Capitol Building in Washington, D.C.

The problems facing states are often masked by lax budget laws and opaque accounting practices, according to the report, an independent analysis of six large states released by the State Budget Crisis Task Force.

It said that the financial collapse of 2008, which caused the most serious fiscal crisis for states since the Great Depression, exposed deep-set financial challenges that will worsen if no action is taken.

“The ability of the states to meet their obligations to public employees, to creditors and most critically to the education and well-being of their citizens is threatened,” warned the chairmen of the task force, Richard Ravitch, a former lieutenant governor of New York, and Paul A. Volcker, a former chairman of the Federal Reserve.

The report added a strong dose of fiscal pessimism just as many states have seen their immediate budget pressures begin to ease. And it called into question how states will restore the services they have cut during the downturn, saying that the loss of jobs in prisons, hospitals, courts and agencies have been more severe than in any of the past nine recessions .

“This is a fundamental shift in the way governments have responded to recessions and appears to signal a willingness to ‘unbuild’ state government in a way that has not been done before,” it said, noting that court systems had cut their hours in many states, delaying actions including divorce settlements and criminal trials.

The report arrived at a delicate political moment. States are deciding whether to expand their Medicaid programs to cover the uninsured poor as part of the new health care law, with the federal government pledging to pay the full cost at first. Public-sector unions feel besieged, as states and cities from Wisconsin to San Jose, Calif., have moved to save money on pensions. And Washington’s focus on deficit reduction — with big budget cuts scheduled for after the fall election — has made cuts to state aid inevitable, many governors believe.

If federal grants to the states were cut by just 10 percent, the report said, the loss to state and local government budgets would be more than $60 billion a year — nearly twice the size of the combined tax increases that states enacted during the fiscal crisis from 2008 to 2011.

Things are worse than they appear, the report contends.

Even before the recession, Medicaidspending was growing faster than state revenues, and the downturn led to higher caseloads — making the program the biggest share of state spending, as states have cut aid to schools and universities. States have not set aside enough money to cover the health and retirement benefits they owe their workers. Important revenue sources are being eroded: states are losing billions of sales tax dollars to Internet sales and to an economy in which much consumer spending has shifted from buying goods to buying lightly taxed services. Gas tax revenues have not kept up with urgent infrastructure needs. And distressed cities and counties pose challenges to states.

While almost all states are required by law to balance their budgets each year, the report said that many have relied on gimmicks and nonrecurring revenues in recent years to mask the continuing imbalance between the revenues they take in and the expenses they face — and that lax accounting systems allow them to do so.

The report focused on California, Illinois, New Jersey, New York, Texas and Virginia, and found that all have relied on some gimmicks in recent years.

California borrowed money several times over the past decade to generate budget cash. New York delayed paying income tax refunds one year to push the costs into the next year and raided several state funds that were supposed to be dedicated to other uses. New Jersey borrowed against the money it received from its share of the tobacco settlement and, along with Virginia, failed to make all of the required payments to its pension funds.

Texas delayed $2 billion worth of payments by a month — pushing the expenses into the next year. Illinois has billions of dollars of unpaid bills and borrowed money to put in its pension funds.

Desperate budget officials often see public pension funds as an almost irresistible pool of money. One common way of “borrowing” pension money is not to make each year’s “annual required contribution,” the amount actuaries calculate must be set aside to cover future payments. Despite its name, there is usually no enforceable law requiring that it be paid.

As a result, the report found that from 2007 to 2011, state and local governments shortchanged their pension plans by more than $50 billion — an amount that has nothing to do with the market losses of 2008, which caused even more harm.

When money is withheld from a pension fund, the arrears can snowball, because most states count on the money compounding at a rate of about 8 percent a year. Eventually the unfunded liability grows unmanageable. And states and municipalities have promised an estimated $1 trillion in health benefits — that most have not started saving for — to their retirees.

While the report called New York’s practice of delaying payments to its pension fund a “gimmick,” Morris Peters, a spokesman for the state’s budget division, said that the state was not relying on any new gimmicks. But the state comptroller, Thomas P. DiNapoli, praised the task force for “bringing the severity of this crisis to the fore.”

Others welcomed parts of the report. Matt Fabian, the managing director of Municipal Market Advisors, a research and consulting firm, said that while it might alarm some investors in the short term, “in the long term it’s a good thing for creditors to get a handle on these costs.”

And Kerry Korpi, the director of research at the American Federation of State, County and Municipal Employees, agreed with its findings that the federal government should consider how its actions impact state and local governments, and that states should modernize their tax systems to pay for needed services.

The task force chairmen said they wanted to call attention to the severity of the problem without making it worse by spooking the investors who buy municipal bonds. State and local governments cannot function if they lose their access to credit, as New York City did in 1975.

Mr. Ravitch, a primary player in resolving New York City’s near breakdown, said he did not see the states’ problems today as analogous. The states, he said, are not juggling the giant load of short-term debt that New York City had back then.

Mr. Volcker disagreed.

“New York City went and spent a lot of money they didn’t have,” Mr. Volcker said. “We’re doing exactly the same thing today on a grander scale.” He said that it was characteristic of financial markets to fail to respond to problems until they became a crisis.

“They’ll lend right up to the brink,” he said. “That’s the lesson of this. You don’t want to act too late.”

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