As Threat of Federal Cuts Looms, Lackluster Revenues Leave States in a Tough Spot

U.S. state governments have experienced sluggish tax revenue growth in the past two fiscal years and governors were cautious in proposing spending increases for the upcoming 2018 budget cycle, according to a new report on state budgets.

These findings come as Congress contemplates major changes to Medicaid that could pose significant new costs for states in future years and as the Trump administration is pushing for deep cuts to federal funds that flow to state and local governments.

The report, the National Association of State Budget Officers Spring 2017 Fiscal Survey of States, was released Thursday.

“The data in this report shows how thin states’ margins are,” John Hicks, the association’s executive director, said during a call with reporters on Wednesday.

“States are challenged to meet current obligations,” he added. Some larger state expenses he highlighted were Medicaid, K-12 education and pension costs for retired public workers.

Estimates in the survey show that fiscal year 2017 general fund revenues in 33 states were coming in below forecasted levels. In other words, these states had planned to collect more money to cover the spending outlined in their budget plans. In 2016, 25 states found themselves in this position. In 2015, there were just seven. This year’s figure is the highest level since 2010 when, in the wake of the Great Recession, 36 states saw revenues fall short expectations.

State revenues come from sources such as taxes on sales and personal and corporate income, as well as from fees.

The survey refers to a number of factors that could be contributing to lackluster state revenues. One is that high earners could be shifting income into the year ahead, anticipating that federal tax cuts will be enacted under President Trump and the Republican-controlled Congress.

Other factors include: declines in oil and natural gas prices and coal production that have affected states with economies that depend on these commodities; greater amounts of economic activity falling outside of the sales tax base of many states; and low inflation.

Fiscal years in all but four states end on June 30, according to the National Conference of State Legislatures.

Budget proposals governors put forward for fiscal 2018 would increase general fund spending by just one percent compared to estimated levels for this year. That would mark the lowest nominal growth rate in spending since 2010, the NASBO report says. The estimated change is based on proposals from governors, as opposed to final budget legislation state lawmakers have approved.

Total state general fund spending for fiscal 2017 is estimated to be $819 billion, up from $782 billion in 2016, according to the survey.

President Trump’s budget proposal for the 2018 federal fiscal year, which begins on Oct. 1, includes cuts to a wide range of federal programs that funnel money to states and localities.

For example, it would reduce Federal Emergency Management Agency grants to state and local governments by $767 million compared to fiscal 2017 and Environmental Protection Agency “categorical grants,” which go toward state environmental programs, by $482 million.

The president’s budget plan also calls for states to pay for a greater share of food stamp benefit costs in the years ahead.

Some of the heavier cuts the Trump administration has proposed target programs focused primarily on local governments, like the elimination of funding for Community Development Block Grants, which were allotted roughly $3 billion during the current fiscal year.

It will be up to Congress to decide which of the president’s spending reductions they’ll go along with. Some of the Trump administation's ideas for slashing costs are getting a cool reception on Capitol Hill.

Minnesota Budget Director Margaret Kelly, who is also NASBO’s president, noted on Wednesday’s call that, in her state, Gov. Mark Dayton, a Democrat, did include a small amount of contingency money for “federal uncertainty” in his two-year budget proposal. State lawmakers did not incorporate those funds into the budget legislation they passed last month.

In the event of federal cuts along the lines of what Trump has proposed, Kelly said “we would need to make hard decisions about what services would get funded.”

Lawmakers in the U.S. Senate are working to come up with health care legislation as part of a GOP-led effort to roll back the Affordable Care Act, also called Obamacare.

The Senate deliberations are for now taking place largely behind closed doors.

But Republican legislation that passed narrowly in the U.S. House last month would restructure Medicaid in a way that would significantly lower federal spending on the program in future years.

Medicaid provides access to health care coverage for low-income Americans.

Key Medicaid provisions in the House bill would not set in until 2020.

Estimates the Congressional Budget Office issued last month show that the House legislation, known as the American Health Care Act would diminish the amount of federal money going toward Medicaid by about $834 billion over a decade-long period ending in 2026.

But there’s been discussion in Congress and among experts about whether the actual number could be higher, possibly in the ballpark of $1.3 trillion. Either way it would confront states with a sizable reduction in federal funds for one of their biggest expenses.

Medicaid was estimated to have accounted for about one-third of all state spending in fiscal 2016. That’s the single largest chunk of state expenditures, the NASBO survey notes. In 2016, total spending on Medicaid included $216 billion from states and $342 billion in federal funds, according to NASBO.

The survey points out that median general fund spending on Medicaid is outpacing the rate of general fund revenue growth.

Kelly said if there were substantial reductions in the amount of federal dollars going toward Medicaid, Minnesota would have to make tough choices about the number of people it could afford to provide with health care and the types of benefits the state would be able to pay for.

“Or we would have to increase revenues to continue to provide the current level of services to folks,” she said.