Bliss or blues: with state revenue performance improving, states appear to have turned the corner on the latest national recession.

• Author: Eckl, Corina
• Position: STATE BUDGETS

State budgets are healthier than they've been in five years, thanks to improving revenues and careful balancing of priorities. Although the downturn seemed to last forever, the turnaround has occurred quickly. While final numbers for fiscal year 2005 are still coming in, the news is surprisingly positive on several fronts. Revenue figures and year-end balances, in particular, stand out as noteworthy.

Part way into FY 2005, lawmakers learned that tax collections were outpacing projections, in some cases by substantial amounts. By March 2005, half the states reported that collections were exceeding forecasts for every major tax thanks largely to increasing employment and rising corporate profits. The reports were even better after April personal income taxes were tallied.

Although robust revenue collections were a welcome change from the situation of recent years, lawmakers were caught by surprise. When they were developing their FY 2005 budgets, states estimated revenues would grow 2.8 percent above FY 2004 levels. The final figure will be closer to 6 percent. Many states used unexpected revenue growth to support supplemental appropriations while others, either through deliberate action or because their legislative sessions already had concluded, left the funds unspent or deposited them into their rainy day funds.

Nationally, states expected to end FY 2005 with a collective balance of 3.6 percent of general fund spending. Estimates now place that figure at 7 percent--nearly twice as high as expected. Although balances are expected to drop by the end of the current fiscal year, they are still projected to reach 4.7 percent.

How long will this relative prosperity last? No one knows for certain, but budget insiders are wary. "Fiscal people never relax, we anguish over this stuff all the time," says Michael Calvert, director of Nebraska's Legislative Fiscal Office. "But as we look at the long-term trends, there are genuine reasons to be concerned."

Any discussion of state budgets and the pressures on them starts with the biggest cost drivers: elementary-secondary (K-12) education and Medicaid. Together, these programs account for nearly 50 percent of state general fund budgets, up from 42 percent a decade ago.

EDUCATION DEMANDS

State constitutions guarantee public education. And K-12 education also enjoys strong bipartisan and public support. It would be politically difficult, if not impossible, to shrink the K-12 share of the budget.

Various factors are propelling K-12 spending. The requirements of the federally mandated No Child Left Behind law are expensive: Experts estimate that the states are shouldering an extra $10 billion annually to comply with the law.

Other factors are fueling costs, too. For years, states have been struggling to address court rulings that their school funding systems are inadequate. Arkansas is one of the most recent states where the system was declared unconstitutional. Lawmakers responded by imposing a 0.875 percent increase in the sales tax and earmarking it for K-12 education.

Most other states are boosting K-12 funding, too. Even in bad times, education usually is spared the budget axe. And now that revenues are improving, K-12 is benefiting. States are raising teacher salaries, enhancing funding formulas, starting new programs or generally increasing their share of K-12 support.

A recent citizen initiative in Maine requires the state to provide a greater share of K-12 educational costs. The original proposal--which raises the state's share from 43 percent to 55 percent--called for the change to occur in FY 2006, but the Legislature is phasing in funding and will reach the target by FY 2009. Maryland is in the middle of a five-year state initiated plan to significantly increase its support for public education. The state has approved $1.3 billion in additional support, which will boost its share of total funding to 47.5 percent from the 40 percent level when the plan originally was approved. Under the current schedule, state aid will increase $500 million per year in the final two years of the program's phase-in.

New or expanding education programs also are raising costs. Delaware lawmakers appropriated $3 million in FY 2006 to continue pilot funding for full-day kindergarten. If the program is implemented statewide, the estimated annual cost is $20 million. Florida's current budget includes $388 million to phase in universal voluntary pre-kindergarten for four-year-olds, a program approved by voters in November 2002. Another voter mandate reduces public school class size by two students annually until constitutionally imposed targets are met. In Oklahoma, lawmakers are using new education trust fund lottery revenues to fund full-day kindergarten and third grade remediation.

Other recent increases in education spending have been driven in part by...