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Growth Lag And Budget Caution In The States

 The U.S. economy is expanding for a ninth consecutive year, unemployment is low, stock indices are near record highs, despite an early August slump, and the Great Recession of 2007-09 is a distant memory. Despite these positives, state budgets for fiscal 2018 are “extra cautious as states contend with slow revenue growth, limited budget flexibility and substantial federal uncertainty,” according to an annual report by the National Association of State Budget Officials (NASBO). Adjusting for inflation, 19 states have failed to reach the revenue levels they enjoyed before the recession.


A recent analysis of state trends by the Pew Charitable Trusts underscored the NASBO findings. “The slow pace of tax revenue growth has left many with little or no wiggle room in their budgets,” Pew found.


There are several explanations for the tight budgets. “The most prominent reason is the slow economic recovery,” said John Hicks, executive director of NASBO. Although the recovery is the third longest in U.S. history, growth has been weaker than in other post-recession rebounds. The annual growth rate — “real GDP,” which is gross domestic product adjusted for inflation — has never reached 3 percent in any of the recovery years. This year growth was a dismal 1.2 percent in the first quarter and 2.6 percent in the second.


Other reasons include a slump in sales-tax revenue and the ever-present shadow of unfunded pension liabilities for state and local government workers and teachers. The gap between the benefits promised to workers and pension fund assets was $1.1 trillion in 2015, the last year for which full figures are available. This was a 17 percent increase from 2014.


Meanwhile, sales tax revenues have fallen below estimates, and states are finding it difficult to collect taxes on Internet sales, Hicks said. Americans are spending less on goods, which are taxed in most states, and more on services, which are broadly taxed in few states. This year bills were introduced in 23 legislatures to align tax codes with the modern service economy and tax such activities as personal care, home repair, funeral services and computer maintenance. So far, none have passed. According to Pew, states with service taxes have found them so complicated that tax offices are writing clarifying memos, such as one in North Carolina to distinguish between roof repair (taxable) and roof replacement (not taxable).

Nonetheless, overall tax revenue is up in 31 states. Most of these states have also rebuilt their rainy-day funds, which are reserves they can draw on during a natural disaster or the next economic downturn.


There are wide variations among the states, reflecting differences in economic conditions and tax policy. The nation’s most contentious fiscal situation is in Illinois where legislators in July overrode the veto of Gov. Bruce Rauner (R) and passed the state’s first complete budget in more than two years. The repercussions from this budget and an accompanying income tax increase continue to rock the Prairie State. Illinois has more than $14 billion in past-due bills and missed a payment to schools this month. Its credit rating is shaky.


States in the nation’s oil patch remain under pressure from declines in production that began with the 2014 oil price collapse. Tax revenue has fallen and job growth stagnated in energy-producing Alaska, Louisiana, New Mexico, North Dakota, Oklahoma and Wyoming, according to an analysis by S&P Global Ratings. Texas, another energy-producing state, has managed to weather the downturn in energy revenue because of economic diversification.


Apart from oil-patch states and Illinois most states have shied away from general tax hikes except for gas taxes. Eight states raised taxes on motor fuels this year, bringing to 26 the number of states that have done so during the past four years.


“There’s nothing more fundamental in the business of government than making sure the roads and bridges don’t fall apart – and they are falling apart,” California Gov. Jerry Brown (D) said in support of a 12-cent hike in the Golden State’s gas tax that is estimated to raise $5 billion.


California is a liberal, Democratic bastion, but the gas-tax raising states this year include fiscally conservative Tennessee and South Carolina, where Republicans are in charge.


“We’ve seen more bipartisan agreement on raising gas taxes than almost any other tax out there,” said Jared Walczak, senior policy analyst at the right-of-center Tax Foundation, quoted by Pew.


The neglect of roads and bridges that brought about these tax increases was also arguably bipartisan. Another factor is continuing improvement in fuel efficiency for cars and trucks, which reduces gas sales and the taxes that go with them.


CNBC rates Rhode Island, New Hampshire, Maine, Connecticut, New Jersey, New York and West Virginia as the seven worst states on infrastructure. Four of these states have Republican governors and three have Democratic governors, but the infrastructure deficiencies began long before any of the present occupants held office.


Some governors are trying hard to overcome past shortcomings. Rhode Island Gov. Gina Raimondo (D) has won plaudits for pushing through the Ocean State legislature a repair program called RhodeWorks. It is funded by charging large commercial trucks a toll. In New Jersey the outgoing governor, Chris Christie (R), although generally unpopular, persuaded the legislature to pass a gas tax increase to fund an additional $400 million a year in road repairs.


The seven best states for infrastructure on the CNBC list are Texas, Tennessee, Indiana, Georgia, Ohio, Kentucky and Florida. These states have long spent heavily on infrastructure and continue to do so. A notable example is Tennessee, where Gov. Bill Haslam (R) in June signed the IMPROVE Act, which relies on gas taxes and user fees to fund nearly a thousand highway projects, while ultimately cutting state and local taxes by $500 million a year.


There are various ways to measure states’ economic health. The Mercatus Center at George Mason University ranks states by financial condition based on tests that include short and long-term budget solvency and unfunded pension and healthcare liabilities. The top five states in 2017 on the Mercatus rating are Florida, North Dakota, South Dakota, Utah and Wyoming. The bottom five are Maryland, Kentucky, Massachusetts, Illinois and New Jersey.


The Wall Street Journal (WSJ) ranks states on pension stability based on the percentage of future retirement benefits that are funded. Illinois is last on this list with only 47 percent of its pension obligations funded. Kentucky also has funded less than half of its obligations. The surprise is Connecticut, which has the nation’s highest per capita income but has funded only 48 percent of its pension liabilities. Alaska and Kansas round out the bottom five.


South Dakota government workers and retirees can breathe easy. The WSJ notes that the Coyote State funds 100 percent of its pension liabilities. Wisconsin, Washington, North Carolina and Oregon come close, financing more than 95 per cent of their liabilities.


U.S. News and World Report rated states this year using more than 60 metrics to measure them on their economic growth and opportunities as well as health, education, safety and much more. The seven top states on the 2017 list are Massachusetts, New Hampshire, Minnesota, North Dakota, Washington, Iowa and Utah.  The seven bottom states are Oklahoma, South Carolina, New Mexico, Alabama, Arkansas, Mississippi and Louisiana.


Such lists are interesting but should be read with large grains of salt and understanding. Louisiana, for instance, at the bottom of the U.S. News and World Report list, has been among the most burdened of states. It had not fully recovered from the devastation of Hurricane Katrina in 2005 when the oil price collapse put a heavy dent in state revenues. Small wonder that the Pelican State is facing a $1.2 billion budget gap in 2018, according to Gov. John Bel Edwards (D).


The rankings reflect the dangers inherent in hyper-partisanship. Illinois and New Jersey, as examples, are struggling in part because Republican governors have battled for years with Democratic-controlled lower houses of the legislature with little willingness to compromise on either side. Contrast that with Massachusetts where Gov. Charlie Baker (R) works productively with a Democratic legislature. Or with California, where Democrats have a super-majority and a governor who prides himself on fiscal restraint. Gov. Brown, liberal on environmental and social issues but tight-fisted on the budget, acts as a brake on the spending tendencies of a Democratic legislature.


Given the weakness and duration of the current recovery and the weight of unfunded pension liabilities, fiscal caution is advisable in any state.