States Running Up Borrowing

September 30, 2009

Some are of the view that state budgets have made it past the worst of the recession and states will be in the clear soon, without the need to undertake large structural reforms and with only a handful of states raising a major tax. Four pieces of evidence suggest that more state budget convulsions are likely.

First, the recovery in state government revenues historically lags behind the general economic recovery. Even if the economy is recovering right now, we will not see that reflected in tax collections for months.

Second, while states are cutting expenses, it’s mostly been of the across-the-board-percentage cuts, state worker furlough, reduction of local aid variety. Few states if any are trying to realize the major savings that could come while improving public services from government pension fund reform, education choice, health care reform, and spending caps (Exception: Maine has a spending cap on the ballot this November). The budget cuts, while sizeable, are more short term and a lot involve accounting gimmicks like moving the last paycheck of the year into the next fiscal year.

Third, it’s the stimulus money that forestalled a lot of tax increases and spending cuts and allowed states to preserve the status quo. $96 billion flowed from the federal treasury to the states in FY 2009, followed by $50 billion in the current FY 2010, and will dwindle to $12 billion in FY 2011 and zero thereafter. Some states took that money and used it for one-time expenses. Other states used the temporary money to put off making hard decisions. (Rainy day funds are about exhausted as well.)

Fourth, states are doing a lot of short-term borrowing:

State governments are rushing to borrow money to take advantage of cheap and plentiful credit at a time when tax collections are tumbling.

Investors, lured by the safety of taxpayer-guaranteed debt, are lending states money at the lowest interest rates in decades.

The borrowing has helped governments increase spending during the recession and avoid some painful spending cuts. Lower interest rates will save governments several billion dollars annually during the life of the debt.

Even financially troubled states are getting large amounts of cash at bargain prices. California borrowed $8.8 billion last week at interest rates of 1.25% to 1.5% for debt due by June 30. That’s about one-third the interest rate it paid a year ago.

“It’s a good time to go out and borrow money,” Utah Treasurer Richard Ellis says.

State and local governments had added $217 billion in new debt this year through last Thursday, up 5% from a year earlier, reports Thomson Reuters. That doesn’t include California’s $8.8 billion debt issue, which closed Friday.

To recap, states are (generally) spending more money than they are bringing in, expecting against most odds that revenues will go up soon, and borrowing and using federal dollars to cover the difference. Sounds like a recipe for fiscal collapse.

Once that happens, states will face a choice. They can take a hard look at the services they provide and how they provide them, with the goal of adopting innovative solutions that reduce serious costs (particularly payroll and defined-benefit pensions) while maintaining the quality of services. There are many great organizations in the State Policy Network with ideas on how to do that in individual states. The other choice is to raise taxes, putting the state in a poor position to attract capital and investment when the economy recovers.


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