State Budget Forecasts Could Shift in a Big Way

The Spring 2018 Fiscal Survey of States, released last week by the National Association of State Budget Officers, examines a combination of proposed spending and revenues for fiscal 2019 and data related to fiscal 2018.

However, all information is self-reported by the states and are preliminary estimates as final fiscal 2018 information is not available until audits are completed—usually by November—and final appropriation laws are enacted by July 1. (Most states are on a July-June fiscal year, albeit several states have other time frames, for example, New York’s budget year is April-March.)

Furthermore, it is particularly important to understand that most governors submitted their budgets for fiscal 2019 before states could incorporate the effects of the federal Tax Cuts and Jobs Act, including both the impact on how each state conforms to the federal tax code as well as behavioral responses by taxpayers to shift the timing of income collections. States are still working to untangle and better understand these impacts which could be significant particularly as to what year to attribute the impact of the tax changes as well as the magnitude—both positive and negative impacts on revenue estimates. Much of these preliminary observations and estimates could significantly change as revenue and expenditure dynamics unfold.

Digging Into the Details

With these caveats, the survey makes the following observations:

• Governors proposed spending increases for fiscal 2019 are 3.2 percent compared to just 1 percent proposed by governors for the current year.
   
• K-12 education received the largest spending boost—$7.2 billion. Medicaid, the second largest component of general fund spending, received the second largest increase of $5.3 billion.
   
• During the current year fewer states—only 9—made mid-year spending reductions compared to prior years, as revenue conditions improved.

• Estimated revenues for fiscal 2018 have grown by 4.9 percent—an increase from the prior year of only 2.3 percent. At the time of the survey, 39 states were meeting or exceeding their original revenue projections, principally driven by increases in sales and income taxes.
   
• According to budgets submitted by the governor’s for fiscal 2019, revenues are projected to increase by 2.1 percent—with the median increase at 2.8 percent.
   
• Governors proposed only modest tax changes for fiscal 2019. Governors in 14 states recommended net tax increases, while 12 states recommended decreases. The revenue proposals with the largest impact include tax increases in New Jersey and Oklahoma.
   
• Medicaid spending is projected to slow. A 1.9 percent growth is expected for fiscal 2019 down significantly from growth patterns of 5.2 percent for fiscal 2018.
   
• Most states continue to strengthen surplus accounts and Rainy Day funds with 28 states calling for increases in fiscal 2019. During the timeline 2011 to 2018 median rainy day fund balances grew from 1.9 percent to 5.8 percent as a share of expenditures. The median balance is expected to increase to 6.2 percent for Fiscal year 2019.

Key Takeaways

This survey provides interesting macro-budget information about current and proposed actions by state governments. However, in addition to the two caveats noted in the Introduction, here are five other important observations:  

• No budget data or comments are included concerning retirement costs—both pension and health benefits—which in many states are significant. While K-12 education and Medicaid are the two largest cost items in state budgets, annual retirement costs are rapidly increasing in most states. Furthermore there are growing unfunded liabilities in many state pension systems—some very significant.  

• The Association of Civil Engineers gives U.S. infrastructure a grade of D+, yet no mention is made about budgetary allocations for capital construction or for debt service for construction bonds.
   
• The survey indicates that proposed state budgets for Medicaid reflect an increase of only 1.9 percent for fiscal 2019—down from 5.2 percent growth patterns in prior years. Demographic data and demand for health services might suggest that such a projected growth pattern is understated and could cause budgetary problems by mid-year. This program needs constant monitoring.
   
• The display of fund balances and rainy day funds in state governments is questionable. A casual reading of the information would suggest the data might not be as accurate as it should.
   
• A good example: the state of Illinois reports a surplus of $10 million. Illinois has multi-billions of dollars of “rolled-over” bills from prior year, including billions to Medicaid providers. Illinois has no surplus, albeit they might have $10 million in cash. A broader question is how is each state reporting surplus—on a cash basis or on a modified accrual basis? Annual Financial Statements of states must be presented on a modified accrual basis but most states do not follow similar good practices in their budgets. In fact, many states report a deficit on a modified accrual basis in their Annual Financial Statement—but in their budget documents indicate they have a surplus—on a cash basis. This is not a good practice and NASBO would do well to have states report such balances both ways. My guess is the numbers would not look so good.

One final point: The survey suggests signs of improvement, especially on the tax and revenue side. But, long term prospects are still challenging. Unfunded retirement benefits, underfunded infrastructure needs, continued threats of federal reductions, and questionable fund balances (surplus) pose future challenges for most state governments.