July 22, 2010

Fiscal Evasion in State Budgeting

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States are entering their third fiscal year of a sustained economic and revenue contraction. Tax revenues have been declining since the first quarter of 2009 and are likely to continue their slide through 2012. Between FY 2009 and FY 2012 state budget deficits will total $300 billion in the states over the next three years. In FY 2011, states face a cumulative budget gap of $89 billion. Federal stimulus funds will be largely exhausted in the coming fiscal year with state source revenues unlikely to return to their pre-recession levels.

While this recession delivered a severe shock to state economies and revenues, the fiscal crisis in the states developed over decades. States have struggled to recover from economic downturns since the early 1980s. Institutions meant to constrain spending such as Tax and Expenditure Limits (TELs), adopted in the 1970s and 1980s, and constitutional limits on debt have also given rise to evasive practices meant to circumvent these constraints and grow spending beyond a legal or constitutionally established limit. The response to budgetary shortfalls in the states since the 1990s has been to resort to fiscal gamesmanship.

With the most recent recession, the choices made by legislatures and governors to balance the books have come under greater scrutiny. Tax increases, spending cuts, and federal bailout funds have each been critiqued through different economic lenses as either supportive of or detrimental to recovery. There is also concern that many of the tactics used to present balanced budgets amount to gimmickry. And more fundamentally, the long-running use of gimmicks is part of the reason most state budgets are in crisis today. In this discussion, the word "gimmick" has been loosely applied to describe a range of choices including school aid cuts, sales tax holidays, increased borrowing, delayed tax refunds, delayed payments to vendors, and pension deferrals. Yet some of the practices labeled "gimmicks" do not violate any accounting standard or budget rule.

To a great extent, a budget gimmick is in the eye of the beholder. Many of the tactics currently criticized as gimmicks have also been described as "budget shortfall strategies," and "expedients." This inconsistent characterization may reflect the inadequacy of government budgeting practice and standards, as well as a general ambivalence over the long-term implications of the accounting choices made in public budgeting. It may also reflect the inadequacy of the word "gimmick" itself. Some of the practices singled out as budget "gimmicks" are a result of a half-century of structural change to state budgets, and the subnational governments' growing reliance on debt and intergovernmental aid.

The inconsistent identification of poor fiscal practice indicates the lack of a common framework against which to assess the fiscal choices of states. This paper establishes a basic definitional framework that can be used to assess long-running fiscal practices in the states against a standard of fiscal prudence. The aim is to further refine this framework to capture the drivers of the states' long-running fiscal problems and to offer recommendations for reform.