Budgets on the rebound? Revenues are showing signs of recovery, but will that be enough to keep state budgets solvent?

• Author: Eckl, Corina

By now it's old news: State budgets suffered historic deterioration during the last national recession. That's what makes the recent news so welcome. Revenues are recovering. So logic argues that the worst is behind us. But unfortunately, it's not that simple. Yes, the revenue dilemma may be easing, but spending pressures show no signs of diminishing.

"Revenues are performing better than expected," says Michael Calvert, director of Nebraska's Legislative Fiscal Office. "But the improved revenue estimate is offset by revised cost estimates."

Nebraska's experience is echoed across the country.

BUDGETS UNRAVEL

Fiscal doldrums began about four years ago. Mid-year budget problems in a few states spread like wildfire, encompassing nearly all of them within a year. Not only was the problem pervasive, it was severe. Lawmakers faced billion dollar budget gaps. As gaps mounted, state year-end balances shrank--a whopping 50 percent drop from FY 2001 to FY 2002.

NCSL's data show that states have closed a cumulative budget gap surpassing $235 billion since FY 2002. How did these gaps develop?

State budgets are built from two sets of data: revenue forecasts and expenditure projections. Lower-than-expected revenues and higher-than-expected expenses lead to budget gaps. It's impossible to predict future revenues and expenditures precisely, but the task is even more difficult when the economy is changing rapidly, as it did at the beginning of the decade.

State finances took a dramatic turn for the worse when the national economy stumbled. Most states saw revenue performance fall below projections--in some cases dramatically below. Many states even reported year-over-year drops in actual revenue collections--a development not seen since the Korean War, World War 11 or the Great Depression. On the expenditure side, a variety of social and safety-net programs outstripped their budgeted levels. The biggest problems occurred in Medicaid and other health care programs. In combination, these factors led to yawning budget gaps.

BRIDGING THE GAPS

The $235 billion gap that states closed since FY 2002 required difficult and unpopular actions. Lawmakers used the easiest solutions--like tapping rainy day funds, deferring spending and delaying capital projects--at the beginning of the downturn. The harder choices followed.

Legislators mostly cut spending to balance their budgets. According to the Center on Budget and Policy Priorities (CBPP), cuts accounted for 42 percent of the actions to close gaps between FY 2002 and FY 2004. In FY 2004 alone, 42 states used targeted or broad spending cuts to bring spending in line with revenues.

One-time revenues also played a crucial role. Nearly half the states used non-general funds to shore up their budgets this year, either by transferring agency fund balances into the general fund or shifting costs to other state funds.

* Iowa shifted $207 million for Medicaid spending to other...