States Need Budget Flexibility to Weather Tough Times

When states face budget shortfalls, policymakers often find that they have limited options when looking to cut spending or raise taxes to fill the gap. The restrictions they face typically come from federal rules, state law, or court orders.

In addition, raising revenue or reducing costs can take time. For instance, corrections spending is largely driven by the size of the prison population and the number of correctional facilities in a state—factors that aren’t easy to change to deal with immediate fiscal troubles.These limitations add up . Improving flexibility and responsiveness is the third of four steps identified in research by The Pew Charitable Trusts that state governments can take to prepare for the temporary budget upheaval caused by economic downturns or other adverse events such as the coronavirus pandemic.

Although there are sound rationales for some of these restrictions, they collectively make it harder for lawmakers to balance their budgets. They also limit lawmakers’ ability to cut in areas that they judge could cause the least harm. Instead, states usually cut disproportionately in areas in which policymakers have more control, such as higher education funding or aid to local governments. With that in mind, officials should assess what constraints they face, whether the constraints are justified, and, if not, whether they have the power to change them.

Louisiana legislators, for instance, have expressed frustration in recent years that large portions of the state budget are off-limits in the regular appropriations process. Like other states, Louisiana had often committed certain revenue sources to specific purposes by law. For example, the state constitution dictates how Louisiana spends the roughly $150 million a year it receives from a 1998 legal settlement between tobacco companies and the states—with the largest share of the money going to college scholarships.

In all, a 2016 study from Louisiana’s legislative auditor found that the state has 370 “statutory dedications”—provisions in law that commit revenue to specific purposes. The study said these dedications total $4.3 billion a year. Although the original purposes may be worthy, policymakers feel they need greater flexibility to meet changing needs and balance the budget.

With that in mind, a legislative panel spent two years reviewing statutory dedications and identifying those that could be eliminated. In 2018, the Legislature ended dedications worth millions of dollars, allowing the money to return to the general fund instead. Going forward, legislators will review all dedications on a four-year cycle.

“I just think it’s much better fiscal policy to have almost all of your funding in state general funds so that you have the discretion to fund things as your priorities change,” said Louisiana state Senator Sharon Hewitt during an interview late last year. Hewitt helped lead the effort to reduce the amount of dedicated funds.

Lawmakers can also increase budget flexibility by being selective when considering decisions that will tie the hands of future legislatures. Some decisions invariably require multiyear investments—a new state highway, for example, can’t be built in a year. But long-term commitments often tie up state dollars regardless of the budget situation. With that in mind, lawmakers should carefully weigh the pros and cons of these decisions and avoid commitments that are unnecessary or counterproductive.

For instance, many states offer tax incentives to businesses for terms of 10, 20, or 30 years, often without an upper limit on how much these promises can cost. In times of fiscal upheaval, states have little power to undo these commitments.

At the same time, leading economic research suggests that money that is promised decades into the future has a minimal impact on business decisions today. By offering incentives on shorter time frames, states achieve a stronger return on their investment, while increasing budget flexibility down the road.

Policymakers also should think ahead about how they could close budget gaps if they emerge. During downturns, almost any approach to balancing the budget will have some negative consequences—from damaging the state’s long-term fiscal position to hurting vulnerable residents to delaying the state’s economic recovery.

By assessing the trade-offs among different options, states can develop contingency plans that focus on the best approaches. If states had had well-designed contingency plans prior to the Great Recession, which started in late 2007, they might have avoided some of their most counterproductive actions, such as cuts to tax collecting staff that cost more than they saved.

Ideally, policymakers wouldn’t just plan for how they might close projected budget gaps in future years. They’d also plan for gaps that emerge during the fiscal year—after legislatures have already adopted their budgets.

Like all states, Arkansas sets a budget based on its most recent revenue projection. In most cases, legislatures must reconvene to adjust appropriations if revenue comes in far below the estimate. In Arkansas, however, a framework for making these decisions administratively is put in place ahead of time by categorizing the budget by level of priority.

When there is a shortfall, agencies eliminate the lowest-priority allocations first and continue until the state budget is in line with the new level of revenue, said Kevin Anderson, assistant director for fiscal services at the Arkansas Bureau of Legislative Research, in an interview earlier this year. That way, the highest-priority programs are protected, and new legislation is not required.

Economic downturns require difficult decisions, but careful planning can help. Policymakers will be better able to make choices that are most consistent with their priorities when they plan for contingencies ahead of time and ensure that they have access to all the tools in their toolbox.

Josh Goodman researches state fiscal and economic policy as part of The Pew Charitable Trusts’ state fiscal health initiative.