Academic journal article Federal Reserve Bank of St. Louis Review

State Government Finances: World War II to the Current Crises

Academic journal article Federal Reserve Bank of St. Louis Review

State Government Finances: World War II to the Current Crises

Article excerpt

States are facing their most severe budget crises in the post-World War II era. Recent data from the National Conference of State Legislatures (NCSL), however, suggest that these budget crises may be softening. Initially, in April 2003, the NCSL reported that aggregate state budget deficits for fiscal year (FY) 2003 would be in the range of $20 to $30 billion, and possibly as large as $78 billion in FY 2004 (1); more than half of the states were projecting a budget deficit in excess of 5 percent of general fund revenue for FY 2004, and one in four states was forecasting a deficit greater than 10 percent. In contrast to the April 2003 figures, the NCSL reported seven months later in November 2003 that state budget deficits totaled $17.5 billion for FY 2003, states projected a cumulative deficit of $2.8 billion for FY 2004, and only ten states were projecting budget deficits for FY 2004. (2)

Much of the reduction in budget deficits is a result of spending cuts, tax and fee increases, and moderate revenue growth that occurred during late 2003. The National Governors Association reported in June 2003 that more than 37 states have reduced their FY 2003 budgets by $14.5 billion using these various instruments. (3) However, the National Governors Association also reported that 19 states (a historically high number) still propose a negative-growth budget for FY 2004.

This article will explore the extent, causes, and proposed solutions of the current fiscal crises from a historical perspective of state finance. Although the current fiscal crises are severe, it becomes more difficult to assess without a more complete understanding of the historical changes that have occurred in state revenue and expenditure streams. This article will address the role of major expenditures and revenue sources in the context of the current slowdown and how reliance on various revenue sources has changed over the past 50 years. The role of nontraditional revenue sources, such as state lotteries and casino gaming, will also be discussed. The article further addresses various fiscal institutions--such as tax and expenditure limitation laws, rainy day funds, and balanced budget rules--and explores the role each play in state budgeting and finance.


State Expenditures

While the underlying cause of fiscal stress is the inability of states to forecast precisely when and by how much revenue growth will decline, expenditures also play an important role in state fiscal health. As Holcombe and Sobel (1997) note, because government services such as education and health care tend to be provided at costs below comparable private sector services, the demand for government services will exceed the state's limited resources. Over the past decade, state budgets have been under considerable pressure from rapidly rising Medicaid expenditures, unfunded federal mandates in the area of health and human services, and a growing prison population.

As Table 1 demonstrates, expenditures for state governments topped $1.18 trillion in FY 2001, with education and public welfare expenditures accounting for more than 50 percent of the typical state's budget. Education expenditures include spending on higher education, elementary and secondary education, Veteran's education benefits, and public libraries. Spending on higher education accounts for the bulk of state education spending, but there has been a trend toward a larger role for states in elementary and secondary education. Public welfare expenditures include outlays related to Medicaid, public nursing homes, children's services such as orphanages and foster care, and services for the homeless.

The largest remaining components of expenditures, in descending order of importance, include insurance trust expenditures, highways, and health and hospitals. (4) Combined with education and public welfare, these five categories constitute roughly 75 percent of state expenditures. …

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