June 16, 2016

The Biggest Movers in State Fiscal Health

Adam Millsap

Assistant Director, L. Charles Hilton Jr. Center for the Study of Economic Prosperity and Individual Opportunity, Florida State University

Between the 2015 and 2016 studies, twenty-two states improved their fiscal standing, twenty-two worsened, and six stayed the same.

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If you follow municipal finance, you are no doubt aware of the fiscal struggles of Illinois, New Jersey, Connecticut, and, of course, Puerto Rico. But many of the structural problems that plague these states occur across the map. Other states that usually go unnoticed in this context — such as Delaware or Iowa — are experiencing similar declines in their fiscal health.

In a new study, the Mercatus Center at George Mason University ranks the states and Puerto Rico by fiscal condition. Unsurprisingly, the states that make the news with fiscal calamities do poorly. But there are also a few states in the middle of the ranking that have fallen with respect to last year’s edition. These warrant a closer look.

Between the 2015 and 2016 studies, twenty-two states improved their fiscal standing, twenty-two worsened, and six stayed the same.

However, since the Mercatus fiscal ranking measures how states perform in relation to one another, an upward change in the ranking does not always signify a real improvement in a state’s financial position. Since larger changes are more apt to capture significant differences in the underlying financial metrics of the states—rather than merely relative differences in position — we’ve highlight those states that moved by five positions or more.

Only Delaware, Iowa, and North Carolina changed positions to such an extent. Delaware and Iowa dropped in the overall fiscal ranking by eight and seven spots, respectively, while North Carolina moved up six.

Delaware, which fell from thirtieth to thirty-eighth, declined largely due to a worsening of their cash and budget solvencies — two short-term measurements of fiscal health that make up part of the overall ranking. Delaware’s cash on hand is declining, it’s spending more money than it’s bringing in, and it’s running an operating deficit. These are all signs of short-term stress, which raise the question of whether the state is prepared for any downturn that might occur in the near future.

Similarly, Iowa, which fell from eighteenth to twenty-fifth, saw drops in cash on hand and assets and a worsening deficit, leading to large drops in cash and budget solvencies. But unlike Delaware, Iowa owes some of this drop to changes in how it reports its finances. A restatement of their assets and liabilities made their previous numbers look worse as well. Still, even without the reporting change, Iowa’s rank would have dropped a few positions. 

Iowa’s reporting change highlights another important issue that the Mercatus study brings to the forefront: transparency. Sound financial statements, backed by accurate actuarial reporting, are essential if policymakers, journalists, and residents are to be able to monitor states’ fiscal conditions.

On a more positive note, North Carolina improved in almost all financial areas, and climbed from twenty-seventh to twenty-first. The state experienced increasing cash balances, a growing surplus, and shrinking liabilities.

North Carolina implemented sweeping reforms to its tax system in 2013, with the goal of reducing the tax burden on working families by broadening the tax base and lowering rates. It’s too soon to know what the effects of all these reforms will be, but North Carolina’s improved fiscal health might well be an early, positive indicator.

Reforming the revenue side of the ledger is just one way that states can improve their ranking and overall fiscal health. It’s also important to reduce spending, which should be done in tandem with any tax reform.

Although moving in different directions in the rankings, Delaware, Iowa, and North Carolina all face growing pension debts. Each of their pension obligations, valued on a risk-free basis, grew by at least 7 percent. Their performances follow the national trend: total pension debt at the national level grew by about 11 percent over the same period.

These trends highlight the difference between relative and absolute changes in fiscal condition. A state may improve relative to others — as was the case for North Carolina — while its absolute performance in some areas remains weak. Even though North Carolina’s pension debt grew by about 10 percent, the state still moved up one spot in the trust fund ranking, which includes pension debt as a component. This is because the pension debt grew at a slower rate in North Carolina than in other states.

This is why it’s important for state officials to focus on improving their state’s finances, rather than their state’s ranking. 

Although two years of data is not enough to establish long-term trends, growing pension liabilities and poor fiscal practices, such as issuing debt to cover spending, will continue to be a problem unless states make substantial shifts towards better financial practices.

As we track the states over time, we’ll learn more about what it means to be on solid fiscal ground. More data will help us discern how much of a state’s improvement is due to better practices, enabling us to draw policy lessons from improving states, which other state officials can implement in order to improve their own finances. 

In the meantime, states can look to Iowa and Delaware for lessons on what not to do — and to North Carolina as a model for how to improve finances going forward.