Volcker Alliance Grades the 50 States According to Their Budget Practices

NEW YORK — During a press conference on Thursday at Hunter College, the Volcker Alliance released a report examining and grading the budgeting practices of the 50 states in an effort to show which have effective budgetary procedures and those that fall short.  

The report is the result of a multi-year study conducted by the Alliance in partnership with more than 50 professors and graduate students in public finance and budgeting programs at eleven schools of public administration or policy. Opening comments were made by Thomas Ross, the president of the Alliance. Presentations were made by Paul Volcker, former Federal Reserve Board chair; Richard Ravitch, former lieutenant governor of New York and William Glasgall, the Alliance’s director of state and local programs.

States were graded in their procedures in five categories:

• Budget Forecasting (estimating revenues and expenditures)
• Budget Maneuvers (using one-time actions to balance the budget)
• Legacy Costs (funding pension and other postemployment benefits)
• Reserve Funds (using rainy day funds and other fiscal reserves)
• Transparency (disclosing budget and related financial information)  

No overall state grade was awarded nor were states ranked—rather each category for each state was given grades ranging from A to D-minus. The grades were based on a research methodology that was as much behaviorally and outcome-based as it was a comparison of numbers. The partnership team conducted interviews with current and former state budget and finance officials, examined budget documents, and other financial disclosure filings. Responses were reviewed and examined across all states, considered state adherence to best practices, and then normalized to account for any discrepancies among researchers’ findings.

The report contains numerous charts summarizing the grades by state and category and lists for each of the five categories what measures were used to determine the grade. For example, in the Budget Maneuver category four measures were used: deferring recurring expenditures; shifting revenue and expenditures to future years; using debt to fund operations; and using asset sales. Each section also discusses which states do a good job in a category and which do not with interesting vignettes.

As noted during the presentation, of the five categories analyzed, funding of retirement obligations is the “most threatening to fiscal stability” amounting, according to the Alliance, $1 trillion in unfunded liabilities for pensions and $600 billion for other postemployment obligations. Other research suggests the unfunded liabilities could be as high as $3 trillion depending on the discount rate being used. Only eight states (Iowa, Idaho, Nebraska, Oklahoma, Oregon, South Dakota, Utah and Wisconsin) received a grade of A for funding of these legacy costs while nine states (Hawaii, Illinois, Kansas, Massachusetts, New Jersey, Pennsylvania, Texas, Virginia and Wyoming) received a D-minus. Curiously Virginia is rated AAA by the Rating Agencies with a funded ratio of 75 percent.

A second troubling category that warranted extensive discussion was Budget Maneuvers, including the use of one-time actions to balance the budget—and the use of cash budgeting that masks the true calculation of surplus. One-time actions, for example, include funding current expenses with debt, using sales of assets, or transferring monies from dedicated funds. By definition the use of these items means they will not be available the following year creating future problems.

A critical problem highlighted by Ravitch was the use a cash basis of accounting to determine surplus rather than a modified accrual basis. This permits expenditures to be recognized  when checks are written not when commitments are obligated—which is the correct manner.

Consider, for example, a situation where a state has an obligation to make $5 billion in Medicaid payments for services provided, but at the end of the year writes checks for only $3 billion. On a cash basis the budget reflects an expenditure of $3 billion—it should be $5 billion as the full obligation will ultimately be paid. This budget practice disguises structural gaps and distorts and overstates the true surplus number. If a state continues this practice for several years it results in mounting real budget deficits—and leads to a significant cash flow problems—think Illinois.      

All presenters recognized this to be one of the real shortfalls in state budgeting practices. Information was not presented as to which states do it correctly and which states do not. A simple test, however, would be to review the table entitled “Budget-To-GAAP Reconciliation” in the Comprehensive Annual Financial Report (CAFRA). The CAFRAs are required to be prepared on a Modified Accrual Basis of accounting—and this simple chart will display the budget problem and suggest the extent of corrective action needed.

Other important items discussed in the report were the need to do consensus revenue estimating rather than have a single person determine the estimate; the desirability to produce multi-year forecasts of revenues and expenditures to help policymakers determine whether future structural deficits are emerging; and the need to maintain Rainy Day Funds and enact clear policies for withdrawals.

Finally, the report stressed the importance of transparency of information. Legislators, executive branch officials and citizens are at a huge disadvantage if it is difficult to dig out the data they need to thoroughly understand a state’s budgeting practices, tax expenditures, infrastructure replacements and debt service costs. One of the most useful devices in providing this kind of transparency is a consolidated budget website.

  The principal benefit of this report is to suggest areas where best practices must be introduced into the budget process. The grades in each of the five categories reflect the fact that while some states follow a broad range of best practices, others fall far short of their peers. One final point: The best budgetary practices in the world will not necessarily lead to the implementation of effective state programs. Such results require sound management practices by executives and the political will of elected officials to adopt and apply them consistently for the long term.  

And, as Volcker noted in the report, "making processes such as state budgeting more transparent is important … and identifying the strongest and weakest among states will encourage new efforts to raise standards for all states."