New Reports Highlight Fiscal Shape of States, Cities

Earlier this year, three separate reports by major national organizations suggested that states and local governments are going to face continued fiscal headwinds into the future. Two new reports by the National Association of State Budget Officers (NASBO) and the Pew Charitable Trusts, respectively, shed additional light on the fiscal shape of state and local governments in the wake of the Great Recession and similarly suggest persistent fiscal pressures.

In November, NASBO released its latest State Expenditure Report, which for the first time in its 26-year history reported a decline in total state spending in FY2012. While general fund and other state fund spending that year actually rose by 2.2 percent, federal transfers to states dropped 9.1 percent (largely due to the expiration of stimulus funds), yielding an overall 1.7 percent reduction in total state spending in FY2012. FY2013 is estimated to improve, with an expected 4.7 percent increase in total state expenditures due to an increase in both state and federal funds. Other findings from the NASBO report include:

• In FY2013, the main revenue sources funding total state spending include general funds (40.5%), federal funds (30.9%), other state funds (26.1%), and bonds (2.5%).
• In terms of total state expenditures (which includes federal funds), the top five spending categories in FY2013 were Medicaid (24.5%), K-12 education (20.0%), higher education (10.0%), transportation (8.0%) and corrections (3.1%).
• In terms of the expenditure of state funds only (general funds and other state funds, excluding bonds and federal funds), the top five spending categories in FY2013 were K-12 education (24.8%), Medicaid (15.9%), higher education (12.8%), transportation (6.7%), and corrections (4.5%).

Looking forward, the NASBO report suggests that fiscal uncertainty is likely to persist in the short- and long-term, given the “slow pace of economic growth, uncertainty surrounding federal fund levels, questions regarding the future performance of state revenue, and increased spending demands.”

On the local front, The Pew Charitable Trusts released a report two weeks ago examining how the 30 largest U.S. cities have fared since the onset of the Great Recession, finding that they have faced major fiscal challenges, have been slow to recover, and felt the downturn’s effects later than the federal and state governments. The Pew report finds that:

• Most of these cities experienced their lowest revenue levels in 2010 or 2011, well after the downturn ended and state government revenues hit their low in 2009.
• A total of 21 cities had not recovered to their previous revenue peaks by 2011, and in the nine cities that did, rebounding revenues were driven more by intergovernmental aid (e.g., state and federal transfers) and increased taxes and fees, as opposed to local economic growth, indicating that their “recoveries [may be] tenuous.”
• Of the 21 cities that had not rebounded to their previous revenue peaks by 2011, eight of them (Boston, Houston, Miami, Minneapolis, Orlando, Phoenix, Sacramento, and Tampa) were still seeing declining revenues.
• Nearly half of the cities (14) saw fluctuations in intergovernmental aid (federal and state) between 2007 and 2011 as a leading driver of revenue changes, in both the positive and negative direction. In nine cities, reductions in federal and state revenue transfers were the primary driver of revenue declines.
• Declines in smaller revenue sources-such as fee revenues, business taxes, and investment income-were a major factor in overall revenue declines in 13 cities.
• Property tax collections remained solid until 2010 and 2011, when they began to fall; 18 cities were experiencing property tax revenue losses by 2011compared to nine cities in 2009. A continued drop in property tax collections could present future budget pressures in some cities in the coming years.
• To address their budget challenges, cities used a variety of strategies. Nearly all of the cities (29 of 30) tapped their reserve (“rainy day”) funds, and average reserve fund levels declined from 18 percent of general fund revenue in 2007 to 14 percent in 2011. Further, nearly all cities cut spending levels, with 24 reducing operational spending between 2010 and 2011. Public safety spending generally took less of a hit than housing/economic development, parks/recreation, public works, and transportation. All 30 cities cut their workforce, with nearly 40,000 city staff positions eliminated between 2008 and 2011.

Moving forward, the Pew report finds that cities can expect ongoing fiscal pressures in the form of reduced intergovernmental aid from federal and state governments, continued sluggishness in property tax revenue receipts, and massive, unfunded government employee pension and retiree healthcare obligations.

To the latter point, the report cited an aggregate $225 billion in funded liabilities-$121 billion in pensions and $104 billion in retiree health care and other nonpension benefits-across all 30 cities. The report concludes that, “in 2010, nearly half of the cities examined were not paying their full, recommended annual contributions to the funds meant to pay for these benefits [..] Deferring these obligations also means that future dollars available for the day-to-day operating functions and services on which citizens rely will be squeezed, as cities are forced to make up the difference for pensions and other post-retirement benefits.”

The full Pew report is available here, and individual city profiles are available here.

Overall, the NASBO and Pew reports add to a body of recent research that suggest that states and local governments face ongoing fiscal uncertainties and continued budget pressures that will hopefully drive policymakers towards greater fiscal restraint and the pursuit of new ways to control costs and increase government efficiency.

Leonard Gilroy is director of government reform at Reason Foundation and is the editor of the Privatization & Government Reform Newsletter, available here.