Credit Scares: Thriftier States Reduce Red Ink

Friday, July 23, 2010

It's kind of like maxing out your credit cards. If you and your neighbor each lose your jobs, you'll both be in trouble, but if you've already rung up big debts, you will end up worse off.

It's the same with the states. Most continue to struggle with billion-dollar deficits, but some are doing a better job of keeping their heads above water than their neighbors. States altogether have closed more than $300 billion worth of shortfalls over the past two years, according to the Center on Budget and Policy Priorities — with more bad news to come. Some are already projecting problems into 2012.

But some states have made a bad situation worse through their own spending and borrowing habits. "Of course they've been hit by the economy," says Scott Pattison, executive director of the National Association of State Budget Officers, "but the way you manage certainly has an art to it."

Illinois Barely Beats Iraq

Such contrasts are clear in the Midwest. All of the states in the Great Lakes region have been hit hard by the recession, suffering multibillion-dollar shortfalls and watching manufacturing jobs continue to evaporate. But they haven't all reacted in the same way.

"It's the Great Lakes states and the housing bubble states that got hit the hardest," says David Wyss, chief economist for Standard & Poor's, a bond rating agency. "Some of them have done at least a halfway decent job of keeping the budget under control, but others are playing games instead of fixing the problem."

Exhibit A is Illinois, which has borrowed freely for years and now finds itself in the worst shape of any state in the country. Last month, its bond rating — the score that determines borrowing costs — fell below that of California. Illinois, in fact, has a lower bond rating than all but seven sovereign countries, ranking just a bit higher than Iraq.

Indiana Gov. Mitch Daniels

Indiana Gov. Mitch Daniels, a Republican, shown delivering the State of the State address Jan. 19, "keeps reminding us that we're in better shape than any of our neighbors," says Ed Feigenbaum, editor of Indiana Legislative Insight.

'Mitch The Knife'

Just next-door to the east, Indiana is, comparatively, in much better shape. It's not glory days in the Hoosier State — every agency has seen its budget cut, most by 10 percent or more. But Indiana started the year with $1.3 billion in savings and has used a little less than half that amount to close a big portion of its shortfall.

State employee salaries have been frozen for two years. Indiana's government now employs its smallest workforce since 1982, with any new hires requiring approval from a special committee.

The austerity approach taken by Indiana Gov. Mitch Daniels, who served as President George W. Bush's first budget director, has been hailed as a model by Republicans running for governor in other states. Daniels intends to sound this theme while campaigning Thursday in Ohio with John Kasich, a former House Budget Committee chairman.

"We would be in a lot worse shape if we had succumbed to some of the tendencies in other states," says Ed Feigenbaum, editor of Indiana Legislative Insight, a capitol newsletter. "It's incredibly tight, incredibly difficult, and the governor keeps reminding us that we're in better shape than any of our neighbors."

Shortfalls Are Continuing

A study released last month by the Rockefeller Institute of Government showed that states collected more money overall during the first three months of this year than during the same period in 2009 — their first quarterly increase since the recession began.

The gains were due largely to tax increases. Even so, revenues still went down in most states. And tax receipts would have to increase by much greater amounts to get states back where they were before the recession began.

The states between the Rocky Mountains and the Mississippi River are doing comparatively well. They have small populations that don't place big demands on state services, and they produce commodities — notably oil and coal — with prices that have held up. Then there are medium-size states like Virginia and Washington, which have budgeted in a responsible manner but are still being buffeted by national economic tides.

It's mostly the larger states that are in the worst position, because of the way the downturn has affected them, the demands their big populations put on services — and their own profligacy and "dysfunctional" political cultures or budget processes, says Wyss, the S&P; economist.

"They just spent too much money in the good times and are not reacting well to the recession," he says. "Illinois and California are sort of in a class of their own, frankly, and it's not the advanced class."

Illinois Gov. Pat Quinn

Illinois Gov. Pat Quinn, a Democrat, shown addressing voters during a Chicago campaign stop Feb. 1, promises to clear up billions in unpaid bills by Dec. 31. But the state still plans to borrow more to pay this year's bills.

Illinois Keeps Digging

California's problems have received a good deal of attention, but Illinois may be in even more trouble. Illinois came up $13 billion short this year — representing more than half its general fund budget. As its new budget cycle began earlier this month, the state carried on its books more than $5 billion in unpaid bills from its previous budget year.

Democratic Gov. Pat Quinn promises to clear up that backlog by Dec. 31, but in the meantime the state is continuing to dig itself in deeper. Quinn's proposal to borrow nearly $4 billion for pension payments — the state borrowed $10 billion for that purpose back in 2003 — passed the Illinois House but was ignored by the state Senate.

But Illinois still plans to borrow more than $3 billion — at high interest rates, thanks to its abysmal bond rating — to pay this year's bills. The legislature last month gave the university systems permission to borrow millions more to make up for the fact that the state has not sent them its promised payments.

"They've been hit hard, but not as hard as Indiana and Michigan, by the recession," Wyss says. "But they haven't been able to get their act together to control their budget problems."

How Michigan Has Managed

Michigan's auto-dependent economy never recovered from the recession of 2001, let alone the one that began in 2007. The state has seen net job losses for nine straight years. State revenues are down to 1988 levels; adjusted for inflation, they're lower than they've been since 1969.

In response, the state has tightened its belt. Democratic Gov. Jennifer Granholm has merged or eliminated some of the state's smaller Cabinet departments, and the state workforce has declined by 12 percent since 2000.

"Michigan has always been pretty responsible in respect to revenue forecasting and budgeting," says Mitchell Bean, director of a Michigan legislative fiscal agency. "We've been in recession long enough and we've been cutting long enough that the initial shock has come and gone."

Indiana and Michigan haven't done everything right. Indiana's pension system is badly underfunded, and budget disagreements in Michigan led to government shutdowns, if only for a few hours, in both 2007 and 2009. But those states have handled tough situations better than some of their counterparts.

As Nick Johnson, director of CBPP's state fiscal project, puts it: "You don't have the feeling of the whole system melting down that you have in California and Illinois."

Ten Troubled States

Nearly every state has had budget problems, but 10 are facing particular trouble, according to the Pew Center on the States:

Arizona: One word: foreclosures.

California: Foreclosures here conspire with difficult budget-writing rules.

Florida: Reliance on tourism and growth doesn't work when population shrinks.

Illinois: A big backlog of Medicaid bills and a long legacy of borrowing.

Michigan: Tough to manage nine straight years of job losses.

Nevada: Gambling and growth are down, and tax law changes require voter approval.

New Jersey: Another state with a long history of papering over its debts.

Oregon: Timber and chip-making are both down.

Rhode Island: Poor financial management meets high unemployment and the region's worst foreclosure rate.

Wisconsin: Heavy reliance on a declining manufacturing sector.

Source: Pew Center on the States