State budget issues, 2011-2012

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State Information

State and local government budgets face unprecedented budget challenges in 2011-12. The National Conference of State Legislatures report found that 15 states have operating budget gaps for FY2011 amounting more than $26 billion, it predicts that next year shortfalls in 35 states will total more than $82.[1] Although some states have seen modest increases in revenue collections, those gains do not fill the budget shortfalls resulting from the loss stimulus funds and other one-time budget balancing solutions used in FY 2010 and FY 2011.[2]

In the past two years, the states have collectively spent nearly a half a trillion dollars more than they collected in taxes.[3] The states also face a trillion dollar hole in their public pension funds.[3] Budgets are top legislative agendas in two-thirds of the states.[4] Concerns about Medicaid, education, revenues, and pensions also loom large for what is expected to be a very difficult budget year ahead.[4]

Leading up to 2011, state tax revenue have increased, compared to what it was a year before and some economists expect national economic growth to be around 3-4% range in 2011. Despite those increases, revenues plunged so deeply in 2008 and 2009 that it will take years for many states to return to levels they saw before the recession. In the third quarter of 2010, overall state revenues were down 7 percent compared to two years earlier.[5]

See also: Find your state budget

Federal Budget Impasse Hits States Hard

President Obama recently increased the pressure by warning Congress that a balanced budget must come prior to an agreement regarding raising the debt ceiling. Negotiations between Republicans and Democrats over increasing the nation’s $14.3 trillion debt limit and developing a balanced budget were stalled. Some lawmakers were advocating for spending cuts, while others pushed increasing revenue (higher taxes).

Many speculated that not raising the debt ceiling would have negative effects of the U.S.’ economy. Economists warned of global impacts: decreased bond ratings and increased interest rates. At home, the President threatens to withhold social security checks, disability payments for veterans, and some federal paychecks should an agreement fail to materialize.[6]

For the states, a debt-ceiling/budget crisis could be devastating to state finances. Under the 14th Amendment to the Constitution, the public debt incurred by the United States is paid first, meaning bondholders will receive their payment first.[7] The U.S. Treasury prioritizes federal distributions, giving first priority to social security, Medicare and Medicaid and unemployment.[8] The long line of payees may mean that the funding many states rely heavily upon will never materialize or will be much less than anticipated. The full faith and credit of the U.S. is on the chopping block and will affect the prosperity of Americans for generations to come.

Impact on the states

With 8 days left before the deadline, states are bracing for the worst, and with good reason. This week, Moody’s Investors Service warned that it would most likely lower the credit rating on at least five states if it downgrades the U.S. government credit rating, placing Maryland, Virginia, South Carolina, Tennessee, and New Mexico at immediate risk.[9] A downgrade will increase the cost of borrowing money in the future and will impact the states’ ability to pay for federal employees’ salaries, make Medicaid payments, and may mean that states must cancel hundreds of contracts.

States depend on the issuance of State and Local Government Series (SLGS) securities for financing. Ceasing the issuance of SLGS securities will likely be the first step in maintain global fiscal solvency if the debt ceiling is not raised.[10] California plans to borrow $5 billion from private investors to cover day-to-day expenses should the federal government fail to enact a budget. Although many states worked hard to balance budgets, most are relying on some federal funding in order to do so in the coming fiscal years. Financial aid to students in Indiana and across the country will drastically decrease without federal contributions. States will face difficulty refinancing their own debt, making transportation repairs, funding social programs such as food stamps, and funding K-12 education. These programs face cuts as high as 40% unless a debt limit agreement is reached.[11]


An end as equally devastating as default for many states is “QE3,” a third round of quantitative easing, whereby the Federal Reserve prints money to cover the sale of bonds.[12] After two arguably unsuccessful attempts to flood the market with newly printed money, the states are now facing the prospect of marked hyperinflation if the Federal Reserve institutes QE3.[13] Inflation refers to the rise of prices as a result of an increase in the amount of money in circulation. Hyperinflation refers to even faster deterioration of the value of currency. As the U.S. dollar’s exchange rate dips well below other currencies, consumer prices will skyrocket. Dollar-denominated commodity prices such as oil and food will push inflation higher as the value of the dollar is continually debased.[14] Since individuals will need higher earnings to pay for necessities, companies will borrow more money to increase wages, thereby accelerating the cycle of inflation.

Coupled with national unemployment rates at 9.2 percent in June, less federal support plus increasing interest rates could ravage individual state economies, possibly plummeting many states into deeper recessions.[15] Poor individual credit ratings means that states will face difficulty borrowing money to make up for the other factors in play. A continued federal impasse might force the hand of many states to cut programs and funding in unexpected areas.

Debt deal approved

On August 2, the Senate passed a bill that cuts spending, increases the debt ceiling, and creates a committee responsible for additional cuts that the two legislative houses failed to make. Almost immediately, President Obama signed the bill, just hours short of the expiration of the deadline.

The plan cuts nearly $1 trillion in government spending over the next 10 years and raises the borrowing limit by $400 billion immediately; President Obama may hike up the limit another $500 billion later, provided he is not actively blocked by a Congressional vote of disapproval.[16]

The 12-member super-committee charged with unilaterally cutting an additional $1.5 trillion from the deficit over the next decade has until Thanksgiving to make recommendations and Congress must pass or fail these recommendations without modification before December 23, 2011. If the recommendations are not created or approved, it triggers an automatic $1 trillion spending cut unless a balanced budget amendment to the Constitution is sent to the states for ratification.[17]

Economists are unsure whether the deal is enough to keep rating agencies from downgrading the U.S. and individual states, respectively. Treasure Secretary Timothy Geithner shrugged off questions today about whether the deal is enough to stave off a downgrade, saying it is not his judgment to make.[18] Rating agencies are still analyzing the deal, but Standard & Poor previously reported that the U.S. must cut $4 trillion over the next decade to avoid downgrading the current AAA rating (the current deal falls $2.5 trillion short of this requirement). States anxiously await ratings from a number of analysts, and uncertainty is growing about the impacts on the national and state-level economies. National and/or state downgrades will likely increase the cost of borrowing money, raise interest levels, and result in underfunded programs such as Medicaid, Social Security and education.

The deal also leaves questions unanswered regarding federal aid for the states. Congressional lawmakers from both parties routinely discuss cuts in discretionary spending over the next decade, specifically with regard to funding state programs. The new timeline in conjunction with the less-representative body charged with making additional cuts leaves states in a precarious position. The panel could institute cuts in federal aid to states without modification or debate, affecting education, social programs, and Medicaid.[19] These costs then shift to the states already struggling to make ends meet amidst declining economic conditions and high unemployment.

Uncertainty in the current economic climate will likely have recessionary impacts on the nation as well as the states. The determination of national and local ratings as well as the ability of the federal government to continue to fund state programs requires time, and time is running out. Within the week, credit agencies will adjust the U.S.’ credit rating.

State deficits data

Some state budgets have been affected by weaker than anticipated revenues and shortfalls in projected federal stimulus funds for Medicaid, but a number of states also are reporting spending overruns. At the start of 2011, about half of the states faced spending overruns in their FY 2011 budgets.[2] California alone is facing a projected operating deficit of $25 billion over the next 18 months; Illinois is facing a shortfall of almost 50 percent in the current year alone.[1]

FY2013 projected budget gaps

24 states currently anticipate budget gaps for FY 2013. Of the 19 states that provided an estimate for FY21012, the sum of these projected imbalances is $66 billion.[2]

FY2012 projected budget gaps

35 states project budget gaps in FY 2012, amounting to at least $82.1 billion as calculated by the National Conference of State Legislatures.[2]

FY2010 budget gaps

In 2010, 48 states reported budget gaps, amounting to a total debt of $1.8 trillion according to State Budget Solutions.

2010 State Budget Gap in Millions (click for full-size)

State Budget Gap.png


Meredith Whitney, a highly respected financial analyst on Wall Street, told “60 Minutes” that She and her staff spent two years and thousands of man hours trying to analyze the financial condition of the 15 largest states to determine if they could repay money they've borrowed and what kind of risk they pose to the $3 trillion municipal bond market, where state and local governments go to finance their schools, highways, and other projects.[3] She said that, due to a lack of transparency, no one really knows how deep the budget holes are.[3]


For detailed information see Public pensions.

States are facing huge pension liabilities, with many sates having skipped scheduled payments in recent years. State and local governments have promised $3.35 trillion in benefit plans and have underfunded these plans by $1 trillion.[20]

Click here for a chart detailing the pension liabilities for each state according to PEW and AEI.

How states deal with the very high pension liabilities will be a big topic as state's determine their budgets for FY2012.

Stimulus Funds

Further complicating matters for 2011-12, states have been relying on $160 billion in federal stimulus funds that will be gone by FY2012.[3] Stimulus funds have bolstered state budgets since FY2009 and the fact that they are coming to an end will result in big holes in state budgets that some officials refer to as the “ARRA cliff.”[2]

In addition, the funds given to states also included large expansion of Medicaid to cover the health care of unemployed workers and single workers without children. In 2011, when the federal funds run out, states will be stuck with one million more people on Medicaid with no money to pay for it. The estimated increase from the temporary increase in the Federal Medicaid Assistance Percentage (FMAP) from ARRA is $87 billion over the 27 months which began October 2008 and ends December 2010.[21] Medicaid enrollment increased by 6.0 percent during fiscal 2009.[21]

A variety of conditions accompany acceptance of the funds. Foremost among them are assurances from states to maintain specific levels of program spending after the stimulus spigot runs dry. Such “maintenance of effort” standards apply to no less than 15 types of services buoyed by ARRA dollars, including Medicaid, K-12 education, road construction, and unemployment benefits. Locked into such spending levels, state legislators now have far less flexibility in budgeting.

Unemployment Insurance

States have relied on $41 billion in loans from the federal government to help cover the cost of unemployment insurance, which has risen due to greater and longer demands for jobless benefits during the Great Recession.[22] Beginning in 2011, states will have to make $1.4 billion in interest payments on those loans. California has borrowed $8.8 billion so far. Only four of the states to take out loans from the account, namely Maryland, New Hampshire, South Dakota, and Tennessee, have repaid their loans in full.[23] States do not have much flexibility to divert funds to make the needed payments on these loans.[23]


Issues to be addressed include enrollment and utilization growth, the reduction in the Federal Medical Assistance Percentage (FMAP) and implementation of federal health care reform. [4]

Rainy Day Funds

Because prior economic downturns resulted in lower than anticipated revenue collections, states established “rainy day” accounts during times of economic expansion to help stabilize budgets from future declines in tax collections. The effort to maintain adequate balances helps mitigate the disruption to state services during an economic downturn. Also, rainy day funds can be used to balance budgets when revenues are below expectations. The informal guideline has been that budget reserve balances should equals at least five percent of total expenditures to provide a relatively adequate fiscal cushion.[21]

Total Year-End Balances as a Percentage of Expenditures, Fiscal 2009 to Fiscal 2011 (number of states)[21]

Percentage Fiscal 2009 (Actual) Fiscal 2010 (Estimated) Fiscal 2011(Recommended)
Less than 1.0% 11 14 15
1.0% to 4.9% 16 16 17
5.0% to 9.9% 14 12 10
10% or more 9 8 8

Budget Cuts

In many states, constitutional requirements direct most of the state spending. That, in addition to debt payments that must be made, leaves lawmakers very little flexibility when it comes to reducing state spending.

Future Years

The outlook for FY 2012 and FY 2013 reveals additional state budget deficits and the National Conference of State Legislatures said it is too difficult to forecast when the vast majority of states will no longer face budget gaps.[2]

Yolanda Kodrzycki, an economist at the Federal Reserve Bank of Boston, told the National Governors Association meeting in July 2010 that budgeting for next year would be "just as tough" for state budget makers.[24]

A report by the Government Accountability Office estimated that if state and local governments continue to operate in the same manner, they will face deficits, debt and unfunded obligations of $9.9 trillion over the next 50 years.[1]

See also