Academic journal article Chicago Fed Letter

State Budgets and the Economy

Academic journal article Chicago Fed Letter

State Budgets and the Economy

Article excerpt

On November 12, 2003, over 70 policymakers, fiscal analysts, and academics gathered at the Federal Reserve Bank of Chicago to examine the fiscal condition of the state government sector. The conference was cosponsored by the Federal Reserve Bank of Chicago and the National Tax Association.

In opening remarks, William Testa, vice president and director of regional programs at the Chicago Fed, noted that despite a shallow national recession that ended in November 2001, state budgets have suffered through three years of fiscal stress and conditions do not appear to be improving. A key question is whether the relationship of state budgets to the economy has changed over the most recent economic cycle. Fred Giertz from the University of Illinois at Urbana-Champaign and executive director of the National Tax Association responded that the recent performance of state budgets (and revenues) suggests a structural change in state fiscal systems.

The first panel featured the state budget directors of Michigan, Indiana, Illinois, Iowa, and Wisconsin. Moderator Therese McGuire from Northwestern University noted that researchers at a conference1 held in spring 2003 emphasized the sharp revenue decline and the political reluctance to raise major tax bases in the recent recession. She suggested that the narrowing and erosion of many tax bases may have exacerbated the recession's impact on state revenues.

Michigan

Mary Lannoye noted that a new Democratic governor was elected in Michigan last year-the first in 12 years. However, Republicans control both chambers of the state house, requiring bipartisan sup port for the budget. Michigan's fiscal year runs from October to September and its budget is principally comprised of two major funds-a general operating fund and a school aid fund-each with a different revenue structure. Revenue declines have been more concentrated in the general fund, which relies on the personal income tax and the state's single business tax. General fund revenues fell in FY2001 and FY2002 and are forecasted to decline in FY2003 and FY2004. General fund revenues of $7.78 billion in FY2004 will be lower than those the state received in FYl993. In contrast, the school aid fund relies on a more stable mix of property and sales taxes and gaming income and has continued slow revenue growth.

Lannoye noted that Michigan's general fund budget has been structurally out of balance2 from FY2001 through FY2004. The general fund spending gap reached $944 million in FY2003 and is estimated at nearly $1.6 billion in FY2004. To close the FY2004 budget, the state made over $1 billion in spending reductions, including 10% cuts to higher education and 9% cuts to local government. Other actions included $240 million in revenue enhancements, nearly $200 million from a revenue sharing accounting adjustment, and $122 million from a change in corrections policy. The state also received $305 million in aid from the federal government as part of this year's special state aid program. As in many states, one of the biggest budget pressures in Michigan is Medicaid. The state's caseload has risen by 232,000 since 2000 and the percentage of the general fund spent on Medicaid has grown from 19% to 25%. It may reach 29% by FY2005. The state's economy continues to be sluggish with quarterly employment growth forecasted as being quite low. Further, given the high level of motor vehicle sales in recent years, auto-dependent Michigan is not expecting the surge in auto demand that it has seen after past recessions. Finally, several of the state's tax bases are being challenged as previously legislated tax cuts are implemented, along with federal changes to the estate tax.

Indiana

Marilyn Schultz described Indiana's budget situation as resulting from a "perfect storm." A court mandate forced the state to replace the property tax assessment system. This resulted in a sweeping state tax restructuring in 2002 that shifted spending responsibilities from the local to the state government. …

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