Oct 29, 2018

State Fiscal Health: What Are Common Traits among the Consistently Good and Bad States?

Olivia Gonzalez Research Associate

This year’s Ranking the States by Fiscal Condition report can tell you how your state’s fiscal health compares to other states. What’s more, after you find out where your state ranks this year, it can tell you whether your state has consistently performed that way or if it’s just been an especially lucky (or unlucky) year for them. This is because we complement this year’s ranking with a 10-year trend analysis, for fiscal years 2006 to 2016. In our analysis, we identify states with consistently strong and weak fiscal performance.

Nebraska, Tennessee, and Utah consistently rank highly whereas New Jersey, Connecticut, and Illinois consistently rank poorly. We usually don’t like to emphasize a state’s rank alone because so much is encapsulated in that one number, and because most states’ stories are pretty nuanced. These states’ performances have stayed relatively consistent, however, making their ranks more meaningful. There are many states that do especially well or poorly in at least one or two categories over time, but these six states stand out for their consistent performance across all areas. In this article, I’ll highlight the patterns for each of these states.

The Consistently Weak States

What do consistently weak states have in common? For starters, they each have experienced their fair share of budget crises. Connecticut is projected to have a $4.6 billion deficit in the upcoming biennial budget. Illinois faces a backlog of nearly $8 billion in unpaid bills and New Jersey narrowly avoided a government shutdown earlier this year by making a budget deal just hours before their constitutional deadline. These issues didn’t arise overnight. Their problems are the result of consistently poor financial management decisions that have led to ongoing structural deficits, rising pension and other post-employment benefit (OPEB) costs, a growing reliance on debt to fund spending, or some combination of these factors.

Each of these states have structural deficits, meaning that their funding issues are not the result of temporary misfortune, but rather an ongoing inability to match revenues with expenses. New Jersey stands out as having particularly weak short-run performance. This state recorded expenses exceeding revenues every year we looked at, pointing to the most severe structural deficit of these three states. Similarly, Illinois’s revenues fell short of the state’s expenses in all but two years. Connecticut has experienced structural deficits in all but four years.

But the primary reason for these states’ negative fiscal condition is the continued growth in their long-term liabilities. Connecticut, Illinois, and New Jersey’s long-term liabilities relative to assets tripled in size between 2006 and 2016.

Long-term liabilities are analogous to the fixed costs that a business can acquire. A business that acquires high fixed costs of production and does not raise sufficient revenue to pay for them is often incentivized to shut down production. A state government is in a different situation because it does not face the same incentives to shut down, but the motivation to cover fixed costs should be the same.

What’s more, a firm that can’t cover fixed costs can stay in business at least in the short run, but does so without producing anything—since doing so would only further drive up its costs. A state government may not “leave the market” any time soon, but the longer it puts off its ongoing financial commitments, the more it risks being unable to provide its basic products: public services.

Growing a state’s fixed costs can crowd out its core functions and its ability to choose new spending priorities for its citizens. That’s happening increasingly at the city and state level. For example, citing rising pension and healthcare costs, Chicago closed 11 percent of its schools in 2013. Cities like Des Moines, Iowa have decreased spending on their libraries, road maintenance, and parks. A study on California found that rising pension costs have been offset by reductions in social services, higher education, healthcare, public works, public safety, and recreation, among other areas. Many reports have documented the necessity for Illinois, Connecticut, and New Jersey to increase payments into their pension systems. That money has to come from somewhere.

These states have already begun to issue more debt to pay for their obligations. To measure this, we look at the net asset ratio for each state—the proportion of net assets, or assets that are left over after the state government has paid its debts, relative to the government’s total assets. The greater the amount of net assets relative to total assets, the more the government has on hand to cover long-term liabilities. Connecticut, Illinois, and New Jersey have each had negative net assets ratios for each year between 2006 and 2016. This means that not only do they not have enough assets to pay for long-term liabilities, but they often issue debt to cover the difference.

A state may have a negative net asset ratio and issue debt for a variety of reasons. When states issue debt for ordinary purposes, such as construction of schools or roads, but do not record the underlying asset, this may lead to the reporting of a negative net asset ratio, which does not immediately signal that the state is in fiscal distress. States like Connecticut, Illinois and New Jersey, however, have begun issuing debt for extraordinary reasons: to cover budget gaps or to make contributions to their pension systems. Issuing debt for spending that should be covered through annual appropriations is a red flag for fiscal imprudence and distress.

Trust fund solvency has weakened for nearly all states, but it has worsened especially in these states. Between fiscal years 2006 and 2016, New Jersey’s unfunded pension liabilities have more than doubled, from 20 percent to 49 percent of state personal income. In Illinois, unfunded pension liabilities relative to state income has tripled from 22 percent to 67 percent. Similarly, Connecticut’s unfunded pensions relative to state income more than doubled from 19 percent to 48 percent.

Consistently Strong States

Now for some better news. What do the consistently strong states—Nebraska, Tennessee, and Utah—have in common? In contrast with the worst performing states, they have all exhibited consistently strong fiscal performance by keeping low levels of debt and unfunded pension liabilities paired with strong short-term fiscal indicators. Nebraska (first) and Tennessee (third) both made the top five this year, but Utah ranked eighth, showing that making it into the top five isn’t everything. Rather, consistent fiscal performance means more for a state’s stability and resiliency.

These states have been able to remain fiscally strong in a period with an economic recession and have recovered better than most states. Most states have kept their long-term liabilities below 50 percent of their assets, but Nebraska, Tennessee, and Utah have exceeded this expectation. Tennessee has kept their long-term liabilities at 10 percent or below of assets, and Nebraska at four percent. Nebraska has kept long-term liabilities at or below 20 percent for most years.

What stands out about Tennessee and Utah specifically is that neither of them experienced a drastic increase in long-term liabilities in FY2015, a phenomena seen in most states as a result of new accounting rules. The implementation of GASB 68 required states to start recording unfunded pension liabilities on their balance sheets. On average, this increased long-term liabilities across the states by 46 percent between FY2014 and FY2015. Tennessee’s and Utah’s long-term liabilities increased 10 percent and 32 percent, respectively, both by a smaller amount than the national average. The fact that Tennessee and Utah don’t follow the same patterns as the national average means that their reporting of pension liabilities was not suffering by as much as other states. Nebraska, by contrast, increased long-term liabilities by 148 percent. Even with this increase, however, Nebraska outperforms many states in this area.

No state has kept pension underfunding to 20 percent or less of state income across the whole sample. Nebraska—followed by Indiana—has come closest to this, with pension-to-income ratios falling below 0.20 over the past several years. However, Nebraska’s and Indiana’s ratios have since risen to 0.22 and 0.23, respectively. Since pension underfunding is such a nationwide problem, even these ratios are competitive in comparison. As for unfunded liabilities, Tennessee and Utah have kept their OPEB-to-income ratios below 0.05, whereas Nebraska has reported no unfunded OPEB liabilities.

As I’ve described in an earlier article in this series, even the most fiscally healthy states have their own troubles, but the good news is that these three states are nowhere near the fiscal messes that Connecticut, Illinois, and New Jersey find themselves in. Nebraska, Tennessee, and Utah each have rising pension costs, but they have much more time and room to work on this than the worst performing states. As long as they keep debt low, pay down pension and OPEB liabilities, and bring in more revenues than expenses, they should be fine. I’ll caveat this by saying that the type of revenue source that states rely on matters. In the next article of this series, I will be talking about the oil-rich states and how a heavy reliance on natural resources for funding operations can be risky.

Photo credit: Mel Evans/AP/Shutterstock

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