Economic Slowdown: How Bad Is It?; Lawmakers knew that robust economic growth couldn't last forever. But they were caught off guard by the rapid deterioration in state finances.

• Author: Eckl, Corina

What a difference a year makes. This time last year, state finances were going strong. Lawmakers were reaping the benefits of the longest economic expansion on record. Unemployment and inflation levels were at notable lows, state revenue growth was robust, and reserve funds were well endowed. For a while, it seemed that the good times would never end. But they have, and the Sept. 11 terrorist attacks on the World Trade center and Pentagon are only making it worse.

The first signs of real trouble emerged last January. As state forecasters analyzed December revenue collections, they realized something was amiss. Sales tax revenue, one of the stalwarts of state revenue growth, was slipping. The timing was critical because holiday sales typically boost December collections. There were also early concerns about personal income tax collections because quarterly estimated payments were lagging projections.

But no one hit the panic button. Instead cautious analysts asked: Were December collection figures just an aberration or a harbinger of things to come? As the last few months of the fiscal year drew to a close, the answer became clear. The economy was changing, and so were state finances. The strong fiscal conditions of a year ago had been replaced by anemic revenue growth and growing budget gaps.

Before FY 2001 had ended, 17 states grappled with budget shortfalls. For the first time in a decade-since the national recession of the early 1990s-a large number of states were cutting budgets, tapping reserves and implementing temporary measures to balance their budgets. And that was just the start. crafting balanced budgets for FY 2002 would be challenging, too. Little did lawmakers know that the task of keeping their budgets balanced would take on new proportions as the fiscal year ensued.

A NEW FISCAL CLIMATE

When legislatures convened their 2001 sessions, policymakers confronted several hard facts: Revenue growth was slowing dramatically, spending-especially for Medicaid-was exceeding budgeted amounts, and a growing number of states faced budget gaps. These facts stirred up distant and unpleasant memories of budgeting under tight fiscal constraints. For the first time in nearly a decade, the economy was forcing lawmakers to make difficult and unpopular budget decisions. For some, the debates led to protracted budget battles. Seven states missed their budget deadlines, the largest number since 1991 when 11 states were late.

The first step for developing FY 2002 budgets was to keep spending in line with projected revenue growth. Although aggregate FY 2001 spending and revenue grew 9.1 percent and 4.5 percent, respectively, the projections for FY 2002 were 2.2 percent and 2.3 percent. These amounts left very little room for school enrollment increases, growing Medicaid caseloads and adjustments for inflation. Lawmakers would have to re-evaluate spending priorities.

MEDICAID MULTIPLIES

For several straight years, education spending outpaced other major categories of state funding. But Medicaid started challenging education for the top spot last year Mid- way through FY 2001, nearly half the states reported that Medicaid was exceeding budgeted levels. In fact by the end of the fiscal year, Medicaid spending had grown by 14 percent over FY 2000. It originally had been budgeted to grow by 6.4 percent. Medicaid is threatening to be a budget buster again, projected to grow 8.8 percent in FY 2002.

With Medicaid spending on the rise and resources tightening, other major categories of spending will feel the pinch. Elementary and secondary education is slated to grow 3.7 percent and higher education 3.6 percent, well below growth levels in recent years.

In the face of sputtering revenues and growing spending demands, many lawmakers searched for new ways to balance their FY 2002 budgets. Many lawmakers opted for belt tightening. Ten states reduced spending, although selected programs often were exempted from the cuts. Arkansas policymakers reduced funding from FY 2001 levels for most state agencies, except for K-12 and higher education, human services and corrections. Iowa lawmakers reduced the FY 2002 budget by $43 million below FY 2001 spending. Actions in Kentucky included a 3 percent across-the-board cut, but K-12 education, higher education and Medicaid were excluded. Michigan lawmakers reduced appropriations by $200 million. South Carolina legislators cut $176.5 million, although public education, colleges and universities were spared. Ohio lawmakers cut appropriations by 1.5 percent but excluded the Department of Education, Board of Regents, Department of Corrections and the Department of Mental Health.

Several states postponed expenditures. Indiana officials delayed a higher education...