(Un)Happy New Fiscal Year

States need fundamental budget/spending reforms to weather the fiscal storm

Let’s not go and get carried away and just look at California as the only state that cannot manage its budget.”-California Gov. Arnold Schwarzenegger to The New York Times, July 2, 2009

Last Wednesday, 46 states began Fiscal Year 2010, but ongoing fiscal woes and the widespread rollout of economy-dampening tax and fee hikes promise to make this one of the more challenging budget years in some time for cash-strapped states.

According to new data from the Center for Budget and Policy Priorities, FY 2010 state budget deficits will top $166 billion across 48 states, and cumulative deficits through FY 2011 may top $350 billion. Further, as and the New York Times report, FY 2010 is already off to an inauspicious start:

  • Legislatures and governors in Arizona, Connecticut, Illinois, Pennsylvania, North Carolina and Ohio failed to agree on FY 2010 budgets as the fiscal year began on July 1. Officials in these states plan to continue essential operations, but the longer they go without a budget, the more day-to-day services in those states would be affected in coming weeks.
  • California remains the poster child of fiscal woe. California policymakers approved a budget in February but declining revenues have that package coming up short to the tune of $26.3 billion. The state has started sending out over 28,000 IOUs to thousands of vendors, contractors, municipalities, financial aid recipients and income tax refund recipients. California needs roughly $3 billion just to cover all of its mandated spending through July.
  • Even in states with approved budgets, budget cuts and tax and fee increases bring heightened economic risk and uncertainty. For example, Nevada will reap an estimated $1 billion in new tax revenues this fiscal year, but will lose by removing those dollars from more productive sectors of the economy that would have had more bang for the buck in terms of growth and job creation. Twenty-five states have already raised taxes this year, according to the Center on Budget and Policy Priorities.

In many ways, while we did see some modest state belt-tightening in FY 2009-and a lot of interest in privatization, streamlining government, and developing fiscally sustainable budget tools and processes-the influx of federal stimulus dollars papered over budget problems in many states and helped policymakers avoid making necessary and politically unpopular reform decisions. According to the Center on Budget and Policy Priorities, stimulus funds have been used to close roughly 40 percent of state budget shortfalls thus far.

Despite routine claims of “decimating vital programs” and “cutting needed spending to the bone” across the states-a predictable rhetorical response on the part of opponents of spending reductions-draconian cuts hardly occurred in most states. Anecdotal evidence suggests that spending cuts rarely exceeded 15 percent for agencies, programs or categorical spending in most places.

But the stimulus gravy train is going to run out, and policymakers are going to have to starting facing the inevitability of substantial reductions in the size, scope and price of government in earnest this fiscal year to close well in excess of $150 billion in budget deficits.

That’s why, for example, the Arizona House of Representatives’ decision last week to let politics destroy a bill that would have created the strongest privatization and government efficiency board in the nation is so disheartening and puzzling (it obviously wasn’t a statement on privatization, as there are several discrete privatization and asset sale/lease proposals embedded in the budget). Conversely, the looming intensification of the budget crunch also explains why the Louisiana legislature’s passage of a bill codifying Gov. Bobby Jindal’s Commission on Streamlining Government into statute is such a prescient and sensible action. The commission was created earlier this year to identify ways to privatize government activities, streamline state agencies and consolidate or eliminate government functions and offices.

These ongoing budget crises serve to highlight a systemic failure in fiscal management by state governments across the country. But at the same time, crisis breeds the opportunity for state budget makeovers. To that end, there are three important steps states should be taking.

First, states need to follow the lead of Washington State, Iowa and others and begin shifting to an outcome-based budgeting system in which policymakers and the public collaboratively rank budget priorities and fund the most important things first. The state government then goes down the list, most important items first, “buying down” with available revenues until they run out of money. This ensures that vital services are being funded before less-critical ones, and services not deemed of the highest important are reduced or eliminated.

Second, states need to embrace privatization, a proven policy management tool around the world. For example, former Florida Gov. Jeb Bush’s administration privatized over 130 services and activities saving taxpayers in excess of $550 million overall over eight years. States could even steal a page from Indianapolis, Phoenix, Charlotte and other local governments that have cut costs and improved the quality of services by allowing public employees to bid against private contractors to provide a variety of services, bringing competitive pressures and incentives to bear on the public sector to drive down costs.

Finally, states should inventory and sell underutilized real estate and lease infrastructure assets to private operators, investing the proceeds from these transactions to pay down long-term pension obligations and support long-term budget relief. Chicago has raised over $3 billion this way since 2005, and many other state and local governments are looking to do the same right now.

Solutions like these need to become part of the fiscal solution for states immediately, because most experts predict that state governments will continue to experience fiscal challenges through at least 2011. As far as Fiscal Year 2010 goes, the only thing standing between a “Year of Fiscal Responsibility” and a “Year of Budget Trauma” is the political will to take the necessary steps to reduce the cost of government.

Leonard C. Gilroy, AICP is director of government reform at Reason Foundation.