by Maurice McTigue and Daniel M. Rothschild

As of March 2010, 49 states faced budget deficits totaling $174.1 billion for the current fiscal year, with higher deficits on the horizon. Largely due to federal stimulus
dollars, mid-year spending reductions, and some creative accounting gimmicks, states technically complied with their constitutional requirements to balance their budgets in 2009-2010. These options however will likely not all be available for the next fiscal year. Moreover, many of these accounting practices are of dubious ethical and accounting value and only serve to postpone dealing with current problems at a higher future cost.

This paper presents a toolkit of seven ideas and procedures for state policy makers to evaluate budget shortfalls and find opportunities for reform. Drawing on domestic and international experiences, we believe the current gap between revenues and expenditures presents policy makers with an opportunity to reevaluate the functions and business practices of their state governments, not only to survive the current economic downturn, but in order to thrive in its aftermath.

Policy makers should shift their focus from addressing symptoms-the disparity between revenues and expenditures-to ameliorating underlying problems. States must seek permanent solutions that will encourage economic growth and bear dividends today and into the future, making their states more economically competitive, employment-rich, and better able to weather future fiscal storms.

1. Addres the problem, not the symptoms.
The problem facing states today is unsustainable spending levels, which resulted from state revenue forecasts that did not anticipate the current downturn. Most states have seen revenues fall significantly below projections in the last two years. In virtually all states, spending has increased for the past two decades at a rate that exceeds growth in income plus growth in residents. According to one calculation, between 2002 and 2007, total revenue to all states' general funds grew by twice the rate of inflation, increasing state revenues by $600 billion. Data from the U.S. Census Bureau show that state and local government revenues increased from $1.32 billion in 2000 to $1.94 billion in 2008, and expenditures increased from $1.27 billion to $2.02 billion over this period.9 These figures suggest that legislatures largely spent this windfall rather than refunding the surplus to taxpayers.

Because the budget deficits they face are caused by spending and not by revenue declines, states must constrain spending in the future. There are three ways states can achieve this fiscal objective.

a. Take surplus revenue off the spending table.
State spending has grown significantly over the last decade, with many states adding or expanding various spending programs with insufficient attention to whether these hikes are sustainable. Legislative devices like Oregon's "Kicker Law" that send surplus revenue to taxpayers or a rainy day fund may be an effective way to help keep spending on a sustainable trajectory.

b. Define and implement responsible budgeting practices.
Legislators should quantify what responsible budgeting looks like so that the public can hold them accountable. Rules that define responsible budgeting give the public a yardstick against which to judge their legislators' spending behavior. Texas's constitutional Tax and Expenditure Limitation (TEL), for example, prohibits expenditure growth in excess of growth in per capita income.

c. Tie spending growth to population or economic growth.
Policy makers should consider enacting tax and expenditure
limitations that tie spending increases to the rate of inflation plus population growth, keeping expenditure constant in real terms on a per capita basis, unless overridden by voters. Alternatively, policy makers may choose to link spending to gross state product (GSP) growth or some other measure outside their direct control.

2. Prioritize. For real.
Ranking government expenditure in order of priority would dramatically improve the debate over which activities get more or less funding in a given budget. David Osborne and Peter Hutchins, in their book The Price of Government: Getting the Results We Need in an Age of Permanent Fiscal
Crisis, stress the importance of holding revenues fixed and determining what services governments can buy for that price. We would take this a step further and recommend that states find ways to restrain spending growth when revenue increases.

3. Demand increased public sector productivity.
Most states begin their budgeting processes by assuming that every department, division, agency, and office should start with the previous year's budget and add some additional funds; this is commonly known as "incremental budgeting."

This practice neither rewards effective performance nor discourages inefficiency. A prerequisite for an item to appear in a budget request should be evidence of the scale and value of the previous year's outcomes. One way states can adopt this rule is by implementing productivity
dividends. Pioneered by New Zealand in the 1980s, productivity dividends assume that, just as the labor productivity of the private sector increases over time, so should the labor productivity of the public sector. For example, output per labor hour in the non-farm U.S. private sector increased by about 2.17 percent per year between 1988 and 2008. This means that the average worker in 2008 was producing about 54 percent more output than she was in 1998 per hour worked. To implement a productivity dividend then, a government reduces budgets automatically by a small amount every year-around 2 percent in nominal terms-and requires agencies to produce the same results with their slightly smaller budgets.

4. Reform the civil service.
Policy makers should consider modernizing state civil services. In most states, the terms and conditions of government employment are based on an industrial-era model of public sector production. In the 21st-century knowledge economy, this model is outdated. Decreasing the hundreds or even thousands of overly specific job descriptions, relaxing the rigid pay bands, and reforming the inflexible hiring and dismissal procedures would improve the quality of management and productivity in government while shrinking its expenses. A "21st-century civil service" would base pay and performance requirements on private sector labormarket equivalence.

5. Review all operations.
A critical review of all the operation and programs funded by a state can uncover economies of scale, obsolete programs where costs exceed benefits, and opportunities to streamline state operations. That is, such a review could find opportunities to prioritize, rationalize, economize, and privatize.

In 2009, Louisiana created a Commission on Streamlining Government, which issued in January 2010 a report with 238 specific recommendations that if enacted would save the state hundreds of millions of dollars. That work contributed to the governor proposing a budget for fiscal year 2010-11 that was 19 percent under that passed for fiscal year 2009-10. In addition, there are now 89 bills in the legislature arising from this commission's recommendations designed to improve the way the state of Louisiana does business and to provide better services and value to taxpayers and citizens.

6. Deliver gods and services, not favors and handouts.
Governments have a duty to taxpayers to buy goods and services from the best providers. In some cases it may be best for states to provide goods and services directly, while in others it may make more sense for states to contract with private providers or to provide citizens with vouchers for certain goods or services that they can spend as they choose in the marketplace. For instance, there may be no good reason for each department in a state to have its own legal department, accounting service, purchasing unit, payroll function, and data collection
and storage facility. In many cases, some departments could easily purchase these services from other departments within the state, creating cost and efficiency gains.

Policy makers should differentiate between desired benefits and methods of delivery; the one does not equate with the other. For example, just because state governments pay to
maintain roads does not mean that it's necessary for them to own the machinery required for filling potholes or to pay the people involved in maintenance directly. It may (or may not) be better value for taxpayers to contract with outside firms to build and maintain roads. Policy makers should maintain a philosophy of buying goods and services from the best providers.

7. Repeal bad ideas.
Not infrequently, interest groups oppose policy innovations on the premise that existing laws forbid implementation. Policy makers should remember that they can repeal laws in favor of new and better ideas. Simply because a statute enshrines a policy does not mean that the policy cannot be improved. Every field of study and practice from medicine to engineering constantly refines its methodologies and techniques; law and public policy should be no different.

Policy makers should not be constrained by current policies just because they are the current policies.

CONCLUSION
States are facing severe budget shortfalls, and at the time of this writing, it appears likely they will get worse before they get better. Legislatures nationwide are in a tight spot. But if states reevaluate their functions and business practices in the process of closing the gap between expenditures and revenues, they will be well-positioned to thrive in the future and avoid the hangovers of overspending.

 

Filed Under : Public Employment Levels, Solutions