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Revenues Slower, but More Stable, Growth
Arizona Rep. Russ Jones thinks the “new normal” for state revenues may not be so bad.
“It’s an old adage that when there’s a boom, there’s a bust,” he said during The Council of State Governments’ 2012 National Conference. “The bigger the boom, the bigger the bust.”
The new normal—with more modest but more stable growth rates—“is a lot more manageable for states than the kind of growth we had before and our reactions to it, both good and bad,” he said.
Rick Mattoon, senior economist and economic adviser for the Federal Reserve Bank of Chicago, said the Great Recession put the U.S. economy—and state revenues—on a recovery path different from the past.
“If you have a very sharp downturn, you usually have a very sharp recovery,” Mattoon said. “What we’re getting (now) is a check-shaped recovery; it takes longer to get back to normal.”
By most accounts, the economy is on the upswing of that checkmark.
As such, so are state general fund expenditures, according to Scott Pattison, executive director of the National Association of State Budget Officers. Since 2011, state spending has increased between 2 and 3 percent. While it’s lower than the 35-year historical average of 5.7 percent, it’s still growth and state budget officers are planning for this slower growth over time.
“They’re strategically planning for that instance, which I think is good because then they’re planning more cautiously,” Pattison said. “We’d rather have money be better than expected.”
That’s been the case the past few years.
In 2009, 43 states had to make cuts to their budgets after legislators had passed them and governors had signed them. That dropped to eight states in 2012, and probably two or three in 2013, Pattison said.
While state balance levels are recovering, Pattison said policymakers are spending more cautiously and putting more money into rainy day funds.
“I think this financial decline really spooked state officials and there’s been an incentive to put more money back into the rainy day funds,” he said.
While some debate the decision to build rainy day funds when, as Pattison said, “it’s still raining,” he encourages states to think long-term when budgeting. Think about how a budget decision will affect things five years out, and don’t spend one-time money on recurring expenses, he said.
“States are realizing that if you have money that is one-time only, you spend it on something one-time only,” he said. “If it gets in the base, we’re going to have a real headache putting that budget together in a couple of years.”
Mattoon said putting more money into savings is a good idea. The problem, he said, is that states need a significant amount of money in savings to truly address problems during recessions.
The historical amount—5 percent of general fund balance—came from credit rating agencies. It’s enough to make bond payments and isn’t based on fiscal stability, Mattoon said.
“(States) would have to save 20 to 25 percent of fund balance to have a rainy day fund to actually carry them through a significant recession,” he said.
While states are putting more into savings, they’re also still pulling out of the recession. As the two programs that pull the lion’s share of state funding—Medicaid and K–12 education—continue to grow, other programs will see less or stagnant funding.
“We have obligations to spend money on Medicaid and K–12 combined that we just can’t meet,” said Colorado Sen. Greg Brophy.
He pointed out that higher education in his state is funded at the same level as 10 years ago, and he suspects other states are seeing the same kind of thing.
“It’s a tough deal in every state,” he said.
Medicaid An Ever-Growing Piece of the Pie
When it comes to budget problems, Medicaid may be the monster in the room.
Not only is it growing faster than other budget areas, but it also faces the potential to gobble up even more state funds. That’s because states will have to decide whether to expand the program for low-income residents as allowed in the federal Affordable Care Act.
If states do expand Medicaid to cover residents up to 138 percent of the federal poverty level, many experts predict people who are eligible now, but not enrolled, will join the rolls. While the federal government will pick up the entire tab for newly eligible enrollees for three years, this woodwork effect will increase Medicaid rolls without the enhanced match rate. Experts expect publicity around the new program will bring in people who haven’t sought Medicaid benefits in the past even though they were eligible. States will receive only their regular match rate for them.
Nearly 20 percent of the population nationwide is enrolled in Medicaid, according to the Kaiser Family Foundation, with total spending in the states ranging from $537.6 million in Wyoming to $52.1 billion in New York for the joint state-federal program.
Scott Pattison, executive director of the National Association of State Budget Officers, pointed out that about 43.5 percent of all funds states get from the federal government go to Medicaid. He expects that number will increase to more than half of federal funding as costs for Medicaid rise.
“That’s really going to change the intergovernmental conversation between the feds and the states,” Pattison said. “It’s going to be really, really focused on health care and less on other areas because that’s where the money is.”
Medicaid is about 24 percent of state budgets, topping K–12 education’s 20 percent, which had always been the biggest percentage of state budgets. K–12 still leads in state general fund spending at 35 percent, Pattison said, but Medicaid has grown to 17.5 percent. General fund Medicaid spending was in the single digits, percentage-wise, 20 years ago.
That fact has states taking a hard look at their Medicaid programs and, especially, at the provision in the federal Affordable Care Act that asks states to expand coverage.
Arkansas is changing from a fee-for-service to an outcomes-based system for provider reimbursement, Arkansas Surgeon General Dr. Joseph Thompson said. For instance, now Arkansas pays one fee for a normal pregnancy and birth and tracks outcome data. This replaces the old system where doctors were paid for each service they rendered for a patient, which many experts think leads to unnecessary services and higher costs.
“We can’t afford the fee-for-service payment system any more,” Thompson said.
Arkansas hopes those changes will enable it to be able to expand its Medicaid program.
“We don’t believe we should expand Medicaid unless we are changing the payment system concurrently to be able to have an affordable system over time,” Thompson said.
Thompson’s department is combing through every health program to see what can be eliminated if services are covered through expansion of Medicaid.
Texas, meanwhile, is not considering expansion, said Dr. Kyle Janek, executive commissioner for Texas Health and Human Services. What Janek would like, however, is broad latitude to design a system specifically for Texas that would allow the state to bend the cost curve.
“The more latitude they can give us, the better system we can develop,” Janek said.
He’ll be seeking waivers from the U.S. Department of Health and Human Services to be able to design a system that works for Texas.
The Pew Charitable Trusts is studying state cost-containment measures that have reduced costs but at least maintained health outcomes. One major measure is Medicaid program integrity, said Matt McKillop, senior associate for research for Pew’s State Health Care Spending Project.
An annual survey found 8.1 percent of total state payments deemed improper; that number has actually been dropping for four years since the federal government began tracking, McKillop said.
“We think—and I think every state would agree—as Medicaid becomes a larger and larger budget item for states, anything above zero is unacceptable,” McKillop said.
Public Pensions In a Better Place, but Still not Whole
Oklahoma had an unfunded pension liability of $16 billion before the 2011 legislative session.
After the state legislature enacted reforms, the liability fell to $10.6 billion. Much of that drop, Sen.
Randy McDaniel said in a Council of State Governments webinar, can be attributed to the fact that any cost-of-living adjustment must be paid for up front.
“By saying you don’t get one or you have to pay for them upfront means that would no longer be unfunded,” McDaniel explained.
Oklahoma is one of 45 states that have made meaningful changes to their public pension plans since 2010. And some that have made changes are facing lawsuits challenging those changes.
While those changes have helped, states still face an unfunded liability for the pension programs for retirees. That means even though those changes are cutting into the unfunded liability levels, states are continuing to look at how to increase solvency for state pension plans.
Keith Brainard, research director for the National Association of State Retirement Administrators, believes the aggregate in public pension funding levels has hit its low mark. Public pensions as a whole were funded at 100 percent in the early 2000s, and dropped steadily to about 76 percent in 2010.
“I think we’ll begin to move upward from here,” Brainard said.
He stressed that there is no national public pension crisis. That doesn’t mean some states and localities don’t have major problems, but some plans are doing just fine, he said.
States began making changes in the mid- to late-2000s. Among other things, they’re requiring employees to make higher contributions, decreasing benefits by setting a higher retirement age, increasing years of service, lengthening the vesting period, reducing or eliminating cost-of-living adjustments, shifting some risk to employees, and increasing the use of hybrid plans—part defined benefit, part defined contribution.
While many states applied those changes to new hires, some used them on current employees and retirees as well. That’s when the lawsuits come.
Colorado, Minnesota and South Dakota, for instance, reduced COLAs almost simultaneously in 2010. They were met the next day with lawsuits. While two are still in flux, Minnesota won the lawsuit on appeal and was able to make cuts.
That broke ground for such changes, and other states are considering them, Brainard said.
A 2010 Pew Research study, “The Trillion Dollar Gap,” brought renewed attention to the problem. The report concluded state policy choices—such as expanded benefits and free retiree health care—were the chief contributors.
Brainard highlighted another major contributor: “The chronic failure by plan sponsors to make contributions in an adequate and timely manner—that’s really what has gotten some of these funds into trouble.”
Some states are looking into pension obligation bonds to retrofill their required contributions. Brainard said that’s not a bad idea for some. The problem, he said, is that plans that shouldn’t be issuing such bonds are the ones doing it.
Brainard predicts states will continue to try to figure out ways to fix the pension systems, and not just because of the impact to their bottom lines.
“We have a moral, legal responsibility to keep the retirement promises that have been made,” McDaniel said. “Reforms are necessary to achieve this goal.”
Unemployment Trust Funds An Uphill Battle
State unemployment trust funds—the funds used to pay out unemployment benefits—took a hit during the Great Recession. Sustained high unemployment rates exhausted those funds, and many states borrowed from the federal government to cover their obligations.
By the end of December 2011, 26 states and the Virgin Islands were borrowing money from the Federal Unemployment Account to help pay growing claims for unemployment insurance benefits; outstanding loans totaled more than $36.4 billion, according to a January 2012 Capitol Research brief, “Unemployment Insurance Trust Fund Loans.”
“States in general lowered taxes when times were good, leaving them particularly vulnerable during the recession,” said Jennifer Burnett, economic policy analyst for The Council of State Governments, who authored that report. “Too much demand and too few reserves just strained state resources to the breaking point.”
As the economy has improved, so have the unemployment insurance trust funds in some states. That, said Burnett, can be attributed to state actions to bring solvency back to those funds. Many states raised taxes and cut benefits; some even turned to the private bond market.
South Carolina, for instance, is slowly increasing its taxable wage base to the first $10,000 of a worker’s wages in 2011, to $12,000 in 2012 and to $14,000 in 2014—the first such increases since 1983, according to a report by the South Carolina Department of Employment and Workforce to the General Assembly. The state also changed its tax system for funding unemployment benefits; policymakers now will set new rates each year to ensure the tax schedule raises enough money to fund benefits. The state expects the fund, which became insolvent in 2008, to regain solvency in 2015.
That’s just one example of the changes states are making.
“Digging out of the financial hole will be slow, and costly,” said Burnett.
Many states are still paying back the money borrowed from the federal government, and now they’re paying billions in interest, Burnett said. Those loans were interest free, but only through 2010.
A Stateline.org article in October said 18 states and the Virgin Islands had paid about $2 billion in interest on those loans as of Sept. 30, 2012. According to the Department of Labor, 19 states and the Virgin Islands still have $26.6 billion in debt on their unemployment trust funds. Among the largest outstanding debt: California, at $10 billion; New York, $3.3 billion; North Carolina, $2.5 billion; and Ohio and Indiana, more than $1.7 billion each.
A 2010 Government Accountability Office report found that a big part of the insolvency problem in unemployment insurance trust funds lay with tax policies and practices in many states.
“While benefits over this period have remained largely flat relative to wages, employer tax rates have declined. Specifically, most state taxable wage bases have not kept up with increases in wages, and many employers pay very low tax rates on these wage bases,” the GAO report found.
Trust fund solvency isn’t the only issue tied to unemployment that could affect state economies.
While unemployment rates have been dropping steadily since July, the national average is still over 7 percent. Some states—like California, Rhode Island and Nevada—all had rates higher than 10 percent in October 2012, according to figures released in November, and long-term unemployment remains stubbornly elevated.
“State leaders have learned a tough, hard lesson over the past few years when it comes to saving and planning for the worst, but those lessons are starting to pay off,” Burnett said. “Fund solvency is beginning to stabilize in many states, thanks to the difficult changes states have made, although the debt accrued during and since the recession will continue to impact some states for the next half decade or more.”