Oct 15, 2018

Why Is Nebraska Ranked as the Most Fiscally Healthy State?

Olivia Gonzalez Research Associate

This year, Nebraska took first place in our annual Ranking the States by Fiscal Condition report, coming before South Dakota (second), Tennessee (third), Florida (fourth), and Oklahoma (fifth). Despite being number one in our ranking, the state has seen budget shortfalls and subsequent budget cuts over the past two years that don’t exactly resemble pristine budget health. The unfortunate takeaway is that even the most fiscally healthy states have their own troubles. The good news is that they are not nearly as severe as the troubles of states that rank toward the bottom of our report, states which I will discuss more in detail in later articles of this series. Even with its shortcomings, however, Nebraska has a lot going for it.

Nebraska ranks 1st primarily because of its relatively lower long-term liabilities and pension obligations. The overall rank is calculated from five sub-solvency areas, with Nebraska’s strongest areas being long-run solvency (ranking first) and trust fund solvency (ranking fourth). The state has very low long-term liabilities (only about four percent of total assets, or $282 per person). That’s much lower than the national average. On average, states held long-term liabilities that comprised more than half of their total assets in FY 2016, about 63 percent. This comes out to $4,386 per person. Nebraska’s long-term liabilities have been growing at a seven percent annual rate since 2006, whereas most states have seen a growth rate of 11 percent.

Nebraska’s unfunded pension obligations, measured at a risk-free rate, come to $20.90 billion. This is quite a bit lower than the national average of $134.82 billion. However, while the state fairs better than others because its unfunded obligations only amount to 22 percent of state personal income (the national average is 43 percent) this doesn’t mean their pension system is without issues. Nebraska’s pensions are only 37 percent funded on a market basis, but the state’s valuations put the pension system at 91 percent funded.

The other main areas where Nebraska performs better than most states are the service-level and cash solvency areas, ranking seventh and twelfth, respectively. Nebraska’s tax revenues only take up about five percent of state personal income, meaning that the tax burden placed upon its citizens is relatively small. If a recession were to hit tomorrow, or citizens were to demand spending commitments that required more revenue, Nebraska would be in a slightly better position than most states to raise taxes. Nebraska also has between 2.95 and 3.95 times the cash needed to cover short-term obligations, which exceeds both the national average and what are considered fiscally healthy benchmarks.

Even #1 Has Its Hang Ups

Although Nebraska’s finances have fared well so far, several issues indicate that the state’s finances could worsen. Fiscal year 2016 marks the first year since the recession that the state did not match or exceed expenses with revenues. Revenues only covered 99 percent of expenses in FY 2016. Revenues have been growing at less than one percent per year between 2006 and 2016, but expenses have been growing at a faster rate.

Nebraska’s financial statements attribute 2016’s shortfall to fewer taxes collected than the previous year. General revenues from taxes, investment earnings, and miscellaneous sources, plus contributions to the state’s permanent fund principal, combined all fell short of the cost of governmental programs by about $52 million. Education, health and social services, and transportation expenses rose significantly in 2016, placing pressure on the state’s revenue streams.

Although a shortfall is never ideal, this does not bring Nebraska down in the ranking because its long-term liabilities are so much smaller than the other states. Nebraska’s work in the long-run solvency area is more than outweighing its slack in the budget solvency area, at least for now.

Further, Nebraska’s underfunded pension system has growing liabilities. With an annual growth of about 25 percent per year between 2006 and 2016, pensions are taking up a larger proportion of state income each year. Nebraska’s growing pension liabilities are an important area for the state to keep an eye on. Additionally, the state should consider using more economically realistic investment return assumptions for its pension plans. They currently range between seven and eight percent but should be closer to three and five percent given actual market performance of the past decade. As number one in fiscal health, Nebraska has a unique opportunity to be a leader in pension reporting transparency.

Nebraska’s growth in spending and unfunded pension liabilities, left unchecked, could pose a more significant problem for Nebraska down the line.

Nebraska’s problems are not limited to internal budget risks. Economist Michael D. Thomas warns about a “fiscal squeeze” that Nebraska and many other states are experiencing. Since the mid-20th century, there has been a general push by the states to push responsibility for revenue collection and spending from local governments to the state level. Additionally, there has been a decrease in Federal spending on state infrastructure as well as increased restrictions for the partially funded projects that remain. These two pressures combine to “squeeze” Nebraska more so than before, making it more difficult for the state to both set and meet its own priorities.

How Did Nebraska Get Here?

All in all, Nebraska is doing well for itself when compared to other states. It has enough cash on hand to cover short-term bills and it has the competitive edge of keeping long-term liabilities lower than other states. Like most states, however, Nebraska should keep an eye on its unfunded pension obligations and be cautious about how its expenses are currently growing at a faster rate than its revenues. Our study helps highlight these different aspects, but it’s also important to provide context by looking at the state’s institutions and policies that helped get Nebraska to where it is today.

The institutions, or fiscal rules and policies, which govern policymakers’ budgeting decisions play a large role in influencing each state’s fiscal health. Does the state in question have a balanced budget requirement? Is there a tax and expenditure limit? Are there separate spending and taxing committees in the legislature? There are many institutions that can help constrain spending and therefore improve a state’s fiscal health. I’ll briefly highlight a couple of institutions that Nebraska has that have helped it secure the financial position it finds itself in today.

A big contributing factor to Nebraska’s low long-term liabilities is its relationship with debt. Nebraska does not have any general obligation debt because of a constitutional provision that prohibits the state from incurring any debt in excess of one hundred thousand dollars. As a result, Nebraska has been able to keep debt at five percent of personal income or below since 2010.

Nebraska also makes a habit of putting any excess money from budget surpluses into its rainy day fund. Pew Charitable Trusts’ extensive research on rainy day fund practices commends Nebraska’s rainy day fund for having defined deposit rules but recommends that Nebraska implement more rules that tie deposits and withdrawals to budget volatility and make withdrawal conditions more defined. Despite the improvements that could be made, Nebraska’s rainy day fund has been accumulating reserves. Mercatus research that used data from fiscal year 2015 found that Nebraska had almost three times the amount of cash needed to cushion itself from a severe recession if it were to hit tomorrow.

As we learned in last year’s edition of the study, promoting a healthy culture of fiscal discipline can help ensure persistently strong fiscal performance. Institutions like Nebraska’s—a limit on debt and a rainy day fund—are two examples of healthy financial management practices that other states should emulate. More on Nebraska’s institutional history can be found in economist Michael D. Thomas’ paper from last year.

Next week, I’ll be discussing what makes Illinois last place in our study. While top-five states like Nebraska usually have a nuanced story, with some good aspects, and some bad, any state ranked in the bottom five will usually have a more straightforward story of fiscal distress and consistently poor policy choices.

Photo credit: Nati Harnik/AP/Shutterstock

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