Deep Dive Into State Budgeting Practices Finds Improvements

State government budgeting practices have shown overall signs of improvement in recent years, but long-term expenses like pension and health care benefits for retired public workers present looming challenges for many places.

Those are some of the takeaways from a new report that the Volcker Alliance, a good government group, released Thursday. The sprawling 163-page report, Truth and Integrity in State Budgeting: The Balancing Act, grades states in five areas related to budgeting and also includes in-depth “report cards” that assess budgeting practices in each state.

"We've seen a steady improvement in our average grades and also in the trends,” said William Glasgall, the Volcker Alliance’s senior vice president and director of state and local initiatives.

“It's generally a positive report,” he added. 

Along with states’ financial obligations tied to retired workers, the need to upgrade aging infrastructure was named as another key expense that state leaders will need to grapple with. States face a shortfall estimated to be nearly $1 trillion for backlogged infrastructure maintenance costs for roads, bridges and other public works, the report says.

The report assigns states high to low grades of A to D-minus in the five categories, which cover  budget forecasting (how and whether states estimate future revenues and costs); budget maneuvers (one-time actions to offset recurring expenses); legacy costs, like pensions and retiree health care; reserve funds; and budget transparency.

In this year’s report, the average grades for all five of the categories saw improvements over a timeframe covering fiscal 2017 to 2019. That’s compared to only four categories seeing improvements for fiscal 2016 through 2018, and three for 2015 through 2017. Six states—Tennessee, Hawaii, Washington, California, Idaho and Utah—received A grades in the latest report in three out of five budgeting categories.

Many states have gradually strengthened their financial footing during the long-running economic expansion—now in its 11th year—that has followed the Great Recession. 

The stronger revenues from tax and fee collections, along with the decreased costs related to areas like safety net programs, that tend to accompany healthier economic times can decrease pressure on states to turn to some of the practices that the Volcker Alliance frowns upon.

Still some states have struggled in certain areas. Take budget maneuvers, for example. The term refers to when states use techniques—sometimes criticized as gimmicks—that shift costs to future years without solving underlying problems.

With a D-minus, Pennsylvania had one of the lowest scores in this category. The state, the report says, used $41.1 million of money borrowed in 2018 to pay capitalized interest on the debt in fiscal 2019, a cost that should have been paid with operating revenues.

Pennsylvania also covered a general fund budget gap at the close of fiscal 2016-17 using $1.5 billion in bond proceeds, the report says.

The state wasn’t alone in resorting to such tactics. Kansas made transfers from its highway fund to its general fund, including $293 million last year. All told, 19 states used at least one revenue or cost shifting measure to help balance their fiscal 2017 to 2019 budgets.

On budget forecasting, Maryland was one of the states that got an A. The state drew accolades for the amount of information shared about how it arrives at the revenue estimates it uses. 

The report also highlights how Texas reworked its revenue and expenditure forecasting practices to look farther out into future years, with a change in statute now requiring the Legislative Budget Board to develop projections for about a decade ahead.

As in past years, the report flags concerns with underfunded pension funds and retiree health care benefits for public employees.

It notes that despite the steady economic growth and stock market gains in recent years, states have managed to sock away only 70% of the assets that they are expected to need to cover $4.4 trillion in pension liabilities they are slated to owe in the coming years.

Retiree health care costs, which make up the lion's share of “Other Postemployment Benefit,” or OPEB expenses, are sizable in some states as well. For example, the report notes that in 2018 California faced a long-term OPEB deficit estimated to be about $85 billion.

“The pension and OPEB legacy costs remain a big problem,” Glasgall said.

With all things related to state budgets, it’s important to recognize that circumstances can vary widely from state to state.

For example, Massachusetts was one of 18 states to receive an A grade in the reserve funds category. The state in 2019 had set aside over $2 billion, or about 5.7% of general fund expenditures, and it employs best practices for savings the Volcker Alliance endorses.

Illinois on the other hand received a D grade on its reserve funds practices for 2017 to 2019. The state’s Budget Stabilization Fund “exists almost exclusively on paper,” the report says, totaling just $4 million last year, equal to a paltry 32 cents for every resident in the state.

Forty-nine states have laws requiring that they have a balanced budget, and lawmakers in Vermont, the one state that does not, develop balanced budgets in practice.

But the report points out that because states largely budget using what are known as cash-based accounting methods, where expenses are recognized when bills are paid, it allows them to declare budgets balanced even if huge costs are shifted to future years.

In contrast, modified accrual accounting, which is generally considered to be a more conservative method, requires costs to be recognized when promised payments are incurred. 

The report says that if states used accrual accounting when crafting budgets it would eliminate the possibility of many one-time gimmicks and could lead to “genuinely balanced budgets.” Glasgall, however, acknowledged that there is currently little impetus for this change. 

Making a shift to accrual accounting for budget-making would likely be an expensive and complex endeavor for states. And no outside force, like the federal government or the Governmental Accounting Standards Board, is currently pushing them in that direction.

“There’s nobody standing out there with a cudgel,” Glasgall said. “Nobody’s going to do this voluntarily.” As it stands with state budgets, he added, “balance is a concept, more than an actual reality.”

A full copy of the Volcker Alliance report can be found here.