To Better Manage Tough Times, States Should Avoid Unsustainable Budgeting

States need to maintain a focus on long-term fiscal health even when they enjoy budget surpluses. Unless states’ decisions are sustainable throughout the economic cycle, they risk making the pain even worse during downturns.

Avoiding unsustainable budgeting is the fourth of four steps identified in research by The Pew Charitable Trusts that state governments can take to prepare for temporary budget upheavals caused by economic downturns or other adverse events such as the coronavirus pandemic.

For instance, in 2007 Louisiana’s budget was flush with cash. Oil prices were surging and the economy was booming, thanks largely to an influx in federal funding to help the state recover from Hurricane Katrina. Policymakers responded with a series of bipartisan tax cuts and spending increases that spanned the administrations of two successive governors, one from each political party.

Less than a year later, oil prices plunged, the Katrina dollars ran out, the Great Recession took hold, and Louisiana entered a period of budget turmoil that was far worse because of decisions policymakers had made when the state was better off. Ultimately, lawmakers approved tax increases and some of the steepest spending cuts in the country. For example, Louisiana spent 38 percent less per higher education student in 2018 than in 2008—the second-biggest decline in the country over that time period.

Louisiana’s experience shows why policymakers need reliable data on whether new initiatives are affordable. Every state other than Hawaii has a process in which staff members produce cost estimates—often known as “fiscal notes”—on proposed legislation. However, the consistency and quality of these estimates varies greatly. To meaningfully protect against unaffordable commitments, fiscal notes need to include long-term assessments of each measure’s budget implications.

In Maryland, for instance, nonpartisan legislative staff members write fiscal notes that, by law, include a minimum of five years of projections. To help inform legislators’ decisions, staff members produce the fiscal notes before hearings on the bills and include written analysis to contextualize the numbers. Then, if a bill passes one house of the legislature with amendments, the estimates are updated, explained Lesley Cook, manager of fiscal and policy notes at the Maryland Department of Legislative Services’ Office of Policy Analysis.

States also need to distinguish between recurring and nonrecurring revenue. Governments often face budget challenges when they use one-time money for ongoing expenses. If a state uses a short-term spike in tax collections to hire more state workers, for example, it may struggle to continue that commitment in subsequent years. 

Some sources of dollars for states are almost always temporary, such as money from legal settlements or, as in Louisiana, federal disaster aid. Others provide revenue every year, such as state income and sales taxes. By identifying one-time money and using it exclusively for one-time purposes, states can avoid putting their budgets on an unsustainable course.

To make these distinctions, states use several strategies. For instance, Alabama identifies revenue sources that are generally nonrecurring and removes the one-time payments when calculating long-term revenue trends. States also can identify temporary spikes in regularly collected revenue sources. Utah measures 15-year growth trends for each of its taxes and deems collections that are above the trend to be nonrecurring.

States also can produce long-term budget forecasts that project revenue and expenditures for multiple future years. For example, Rhode Island’s executive budget office produces a five-year forecast annually. These forecasts have led state leaders to recognize that Rhode Island faces a structural budget deficit: Projected revenues fall short of expenditures in each future year, and the gap will grow over time.

“Obviously, we are going to have to raise more revenue, or start cutting our expenses,” Rhode Island Senate President Dominick J. Ruggerio (D) said in late 2019, before the pandemic created a host of new challenges for states.

By routinely identifying and quantifying structural budget deficits, long-term forecasts can lead to better decision-making during downturns, such as the one states now face. If a state’s fiscal problems are a temporary result of economic conditions, relying heavily on reserves to balance the budget makes sense—there may be little need to pursue potentially harmful cuts or tax increases if the state will be back on sound footing once the economy recovers. If the problem is structural, however, less desirable options may eventually be unavoidable.

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