Faulty Structures: Report puts spotlight on threats to states' fiscal stability

This session, the Oklahoma legislature debated a slew of proposals to cut and, in some cases, eliminate Oklahoma’s personal income tax. While some proposals were revenue-neutral, doing away with tax credits and deductions to offset cuts to the top marginal rate, others would have substantially reduced state revenues over time without any plan for how to meet the state’s commitments and obligations. In commenting on the failure of this year’s tax cut plans, OK Policy urged that the next stages of the debate on tax policy be much more mindful of the state’s fiscal context:

 Going forward, we must have a more honest and well-informed debate about what we expect from state government, how much our obligations will cost, and how we will pay for them.

A major new study offers a vivid sense of the momentous fiscal challenges facing Oklahoma and all states. In a 108-page report issued in July, the State Budget Crisis Task Force, a bipartisan group co-chaired by former Federal Reserve Chairman Paul Volcker and former New York Lieutenant Governor Richard Ravitch, contends that even as states recover from the fiscal shocks associated with the Great Recession, they remain mired in a longer-term crisis. The Task Force’s conclusion, they say, is ‘unambiguous’:

The existing trajectory of state spending, taxation, and administrative practices cannot be sustained. The basic problem is not cyclical. It is structural. The time to act is now.

The idea that states face structural budget deficits, or ongoing gaps between the cost of providing services and the revenues to pay for them, has long been recognized (see here and here for national discussions of structural deficits, and here, here and here for Oklahoma’s situation). Yet this new report is especially valuable for two reasons.

First, it shows how state structural deficits have been worsened by the recent recession.  Two years into the economic recovery, state revenues have yet to return to pre-downturn levels. State and local governments have laid off public employees in substantial numbers. Many cuts that might have been temporary in previous downturns now seem permanent, stretching the capacity of state agencies to perform key functions. The report suggests that “this is a fundamental shift in the way governments have responded to recessions and appears to signal a willingness to ‘unbuild’ state government in a way that has not been done before.”

The report is even more valuable for clearly identifying and discussing the gravest threats to state fiscal sustainability. Their six threats involve a combination of spending pressures, revenue weaknesses, and restrictive budget laws and practices:

1. Medicaid spending growth is crowding out other needs: Medicaid costs are outpacing revenue growth, and are absorbing increasing shares of state budgets. As the Baby Boom generation retires, the health care costs of an aging population will continue to grow. The report does note, in the wake of the Supreme Court’s recent decision, that “for states that want to increase coverage for the uninsured, the Affordable Care Act is a bargain”;
2. Federal deficit reduction threatens state economies and budgets: As Congress gets more serious about reducing the deficit,  direct grants to states, under both entitlement programs like Medicaid and discretionary programs like education and transportation funding, are likely to be cut back. States will also feel the economic effect of cuts in direct expenditures for federal programs, from military bases to food stamp payments;
3. Unfunded retirement promises create risks for future budgets: Many state and  local public pension systems have large unfunded pension liabilities that will need to be addressed by increasing contributions from both employers and employees;
4. Narrow, eroding tax bases and volatile tax revenues undermine state finances: The report focuses especially on lost state and local sales tax revenue to Internet sales and on the volatility of state income tax collections;
5. Local government fiscal stress poses challenges for the states: As local governments struggle with narrow tax bases and mounting obligations, there will be increasing pressure on states to increase or at least stop cutting aid to local governments for education and other services;
6. State budget laws and practices hinder fiscal stability and mask imbalances: Inadequate budget reserve funds, reliance on budgeting gimmicks and non-recurring revenues, and the absence of meaningful multi-year forecast plans hinder efforts to maintain a fiscal balance.

This list of national threats may not exactly mirror Oklahoma’s situation, but in general terms, our situation is similar and equally urgent. Unless and until Oklahoma policymakers understand the threats to fiscal stability and the magnitude of the structural deficit facing Oklahoma, any irreversible decisions about tax cuts are certain to be poorly-informed and ill-advised.