Federal Funds

A Way Forward for State Budgets after COVID-19

JONATHAN WILLIAMS, SKIP ESTES

 

Most states close their books for fiscal year 2020 this week and continue to look at the uncertainty ahead. Every state but Vermont has some variety of a balanced budget requirement. Some are far more meaningful than others, but at least some thought goes into presenting a plan to balance revenue and expenditures. Moreover, states lack the federal government’s ability to print money – and engage in quantitative easing.

 

The COVID-19 pandemic and government-ordered economic shutdowns have created a crisis for many state policymakers – especially in states that did not save for the proverbial “rainy day.” For instance, Illinois’  rainy day fund would only keep the state running for about 15 minutes. Shockingly, despite the longest economic recovery on record over the past decade, 22 state unemployment trust funds were below the recommended balance at the beginning of the economic shutdown.

 

Unfortunately, state budgets passed prior to the shutdown anticipate revenues that are no longer there and use forecasts that no longer match economic realities. Some states reliant on more volatile forms of taxation, such as corporate and progressive personal income taxes, have a more acute budget problem than states with more reliable tax bases. Many lawmakers in the states with the largest budget gaps have petitioned Congress for a federal bailout.

 

It is increasingly clear many tax-and-spend politicians have no intention of using the relief a federal bailout might provide to fix structural problems in their budgets or reform state unemployment programs. Illinois lawmakers passed a budget  that increases spending by $7 billion to $84.5 billion for fiscal year (FY) 2021 and relies on $5 billion in borrowing from the Federal Reserve’s temporary Municipal Liquidity Facility (MLF). Despite proposing some budget cuts, New Jersey Governor Phil Murphy has supported a plan to borrow as much as $5 billion in bonds and MLF funds. Spendthrift states expect to use the temporary relief of the MLF as a band-aid while ignoring recurring budget problems that were present long before COVID.

 

Worse yet, state reliance on federal spending comes with a plethora of strings attached. Federal spending is notorious for tying down state budgets with unfunded mandates. Portland State University Professor Eric Fruits found every $1.00 received by states from the federal government costs state and local taxpayers $0.82 in increased taxes and fees, on average. Allowing unfunded mandates to build up effectively surrenders state-level policymaking to unelected federal bureaucrats. States must resist a federal bailout and tackle the root cause of unbalanced budgets: bloated government and  uncompetitive economies.

 

Pundits arguing states can solve their structural budget problems with tax increases seem to ignore that the highest-taxed states oftentimes have the most chronic budget problems. New Jersey, Illinois, Massachusetts and Hawaii are the states with some of the largest average budget deficits as a share state revenue from FY 2004 to FY 2018 – and some of the highest tax burdens. On the other hand, Alaska, Wyoming, North Dakota and Utah have the largest average surpluses over the same period and some of the lowest total tax burdens. Unbalanced state budgets are partially the result of a decaying tax base caused by high taxes. The highest-deficit states mentioned above have seen over 1.5 million taxpayers on net leave for low tax states from 2008 to 2017. It is no coincidence these are also some of the highest-taxed states.

 

Considering a federal bailout is a siren call, and tax increases are not a workable solution over time, states must consider budget reforms to solve the budget crises caused by the COVID-19 economic shutdown. ALEC research has produced tried-and-true methods for states to solve budget crises without passing tax increases.

 

First, states should reorient their budget process toward priority-based budgeting.

 

Reprioritizing government spending might cause some short-term pain, it is the only real, responsible long-term solution to budget challenges. In fact, according to the State Budget Reform Toolkit, Washington state used priority-based budgeting – on a bipartisan basis – after the market downturn in 2001 to close a $2.4 billion deficit, without resorting to burdensome tax increases. To get the process started, policymakers asked themselves a few, key questions:

 

  • What are the results citizens expect from government?
  • What strategies are most effective in achieving those results?
  • How should we prioritize spending to buy the activities that are most critical to implementing these strategies?
  • How will we measure progress?

 

Asking difficult questions like these and taking on the heavy lifting on the spending side of the ledger is the only way to avoid economically damaging tax increases and the only way to ensure a better economic future for all Americans.

 

Second, states should enact other temporary reforms to accurately reflect the state’s fiscal situation. Enacting a state hiring freeze will pause new administrative spending and require agencies to reprioritize human resources. Eliminating positions vacant for more than six months represents an efficiency gain for state agencies, as the agency can reallocate resources formerly allocated to unoccupied and evidently unnecessary positions. These reforms will also be in step with the private sector, as private companies must reprioritize their own resources during an economic downturn. Since government is accountable to taxpayers, it is sensible that government tightens its belt in response rather than hitting hardworking taxpayers with tax increases.

 

Third, after spending re-prioritization, states should utilize unallocated funds to make up for lost revenue. Going into the COVID-19 economic shutdown, many state budget stabilization funds – sometimes also known as “rainy day funds” – hit record funding levels. States should use rainy day funds as an alternative to raising taxes. When possible, states should use unallocated revenues and “orphan funds” – or funds allocated to no longer existent purposes – to further close their budget deficits.

 

Fourth, state government should reexamine their involvement in the private sector and avoid competing directly against job creators. If a good or service is provided by a private sector firm, evaluating options to save taxpayer dollars through a competitive bidding process can provide large savings in many cases.

 

State governments are also some of the largest real property owners in each state. Taking inventory and auditing state-owned real property, then offering lease opportunities and selling unutilized and under-utilized property can increase the efficiency of state government and generate a large amount of revenue to close the budget deficit. Plus, turning real property over to the private sector can increase capital available to businesses looking for ways to grow. New business investment leads to more jobs, higher incomes, and new tax collections for core government services.

 

Tax-and-spend pundits have offered a false choice that budget deficits resulting from the COVID-19 economic shutdown can only be closed by either a federal bailout or increasing economically damaging taxes. Both should be a non-starter for states, as federal dollars come with costly strings attached and higher taxes set states on a path of lower economic growth and an uncompetitive economy. The budget reforms outlined above offer states a way forward by increasing the efficiency of state spending and utilizing tools specifically designed to help states weather a fiscal crisis.

 

This article originally appeared on June 25, 2020 and is reprinted with permission from the American Legislative Exchange Council (ALEC)