Some State Budgets Will Never Be the Same

When the U.S. Census announced earlier this month that state tax collections had increased robustly last year, by 10 percent, the news was hailed as further evidence that the economy was bouncing back and that state and local budget pressures were sure to diminish as a result of all that extra tax money.

But budget tensions haven't disappeared in many places despite the good news on taxes, and that's not surprising when you look beyond last year's tax numbers. Even with that big gain, states collected less in taxes last year than they did three years ago. On top of that, revenue from the major tax that sustains municipal government in America, the property tax, is still falling thanks to steep drops in property values.

The budget downturn, in short, has lasted so long for some states and localities that it has created a new fiscal reality, one in which the old spending formulas that states employed before the recession of 2008 are largely out of date and impractical. That's why even in some places where tax collections soared last year, like Illinois, the budget situation has grown worse, not better. Absent some fantastic and unexpectedly strong economic recovery and stock market rebound, budgets are unlikely any time soon to resemble those free-spending financial plans of just a few years ago.

For one thing, government spending continued rising over the last three years, even as revenues were falling. From 2008 through 2010 (the latest year data are available), state spending rose to $1.9 trillion, from $1.7 trillion. How did states do that? They relied temporarily on federal stimulus dollars that have since disappeared, for one thing.

Politicians also employed a host of gimmicks to put off the budgetary day of reckoning, hoping that the downturn would be briefer than it turned out to be and they could simply bluff their way through their fiscal problems. Arizona floated $450 million in debt secured against future lottery revenues and used the money to plug budget holes. The state also ‘sold' its government office buildings and then leased them back for $1 billion in borrowing.

Rather than use tax money, Illinois, meanwhile, borrowed $7 billion in 2010 and 2011 to make annual required contributions into the state employee pension funds. The state also stopped paying some bills, accumulating $4.5 billion in additional debt to vendors. California ‘balanced' its budget by issuing $2.6 billion in IOUs.

States are now having to start paying off these gimmicks at a time when their budgets remain under pressure. Illinois' annual debt payments for its persistent pension borrowings will cost the state budget $1.6 billion this year, up from $466 million in 2009. Arizona will have to spend $1.5 billion in principal and interest costs to pay off its $1 billion sale and leaseback of state buildings.

This downturn is also different because of the nature of much of the spending pressure on budgets. It comes not from programs that can be cut, but from promises for benefits made to workers that have already been earned but still need to be paid for. Many states and cities are only now discovering, at the worst time possible, just how much money they owe to workers in retirement benefits after years of making those promises without bothering to total up the bill. The nature of the crisis was perhaps best captured by a recent headline in the Chicago Tribune which read: "Surprise. You owe another $54 billion." That was a reference to commitments the state made to pay for retirees' health benefits, which have never been funded (or previously even totaled up, apparently)

The situation is so bad in some places that total debt, including borrowing and unfunded retirement liabilities, amounts to seven or eight times total annual tax collections. Several years ago, for instance, the treasurer of Cook County, Ill., Maria Pappas, demanded that all of Cook's municipalities report their debt to her. It wasn't easy. They began with bonded debt, then totaled up pension liabilities, then found they had lots more they'd promised to workers for health care.

The small suburb of Evanston alone reported some $322 million in debt, or four times tax revenues. But pension obligations amounted to another $203 million in unfunded liabilities. In all, county residents owed on average $32,000 per household, on top of what they as residents of Illinois also owe. If government debts are nothing more than tax revenues that haven't yet been collected, Cook County is going to need a lot more taxes pouring into coffers in the next decade just to pay what it already owes.

We couldn't get a handle on just how much debt states and their municipalities have accumulated unless every county treasurer does what Pappas did. But just what we can estimate in bonded debt and unfunded pension and health care promises for retirees now totals about $8 trillion. That's a lot of future state and municipal tax revenues already accounted for.

The debts, however, aren't equal across states and municipalities, by any means. Every resident of Connecticut for instance, owes $8,221 towards paying off promises politicians have made to workers for health care in retirement. By contrast, residents in Indiana and South Dakota owe less than $90 each for the same unfunded promises.

It should make you think twice before you pick up and move your family or your business somewhere. Some places will spend a long time digging out from their fiscal mess, and you will be asked to pay for it.