For the past three years state governments have faced a continuing fiscal crisis, one of the worst in decades. Though the U.S. economy has recently shown signs of improvement, the National Governors Association believes that the current dire financial situation among most states will likely continue into FY 2005, perhaps longer.¹

In FY 2003 alone, for example, the cumulative revenue shortfall among states was roughly $80 billion (NASBO, 2004, p. 5). The consequent impact on state expenditures—services and programs—has been described as “wrenching.” To balance budgets, many states have been forced to cut or downsize critical programs, leaving children, families, and those in need of state services at considerable risk or hardship.

In reaction to the ongoing crisis, states have done everything conceivable to shore up the revenue gaps in state budgets. Governors and legislatures have enacted across-the-board cuts, laid off employees, reorganized state agencies and programs, and tapped special governmental funds or accounts. In several cases, taxes and fees have been raised.

In the following narrative, the general fiscal condition of the states will be examined highlighting contemporary revenue actions and spending. Next, some of the problems contributing to the financial crisis among states will be briefly discussed. This will be followed by a short discussion on states’ spending priorities and budget balancing strategies. Finally, some brief comments on current state tax actions will be reviewed.

General Fiscal Condition of the States
The fiscal problems confronted by states today are ones that have been experienced before. Most observers and experts in state financial matters understand the cyclical nature of state revenues (as well as expenditures). For instance, the early 1980s was marked by a period of acute revenue shortfalls, as was the case in the early 1990s. In intervening years, i.e., the mid-to-late 1980s and 1990s, periods of significant revenue gains were evidenced.² Thus, this “up and down” in state revenues reflects what experts designate as the classic, recurrent “boom and bust” cycles.

In the section that follows, a few observations on the current general fiscal condition of the states will be made. This will include some remarks on revenue actions and state spending.

The Fiscal Crisis

The National Association of State Budget Officers (NASBO) reports that “nearly every state was in a fiscal crisis, of sorts, during FY 2003.” Shortfalls again were estimated to total an astounding $80 billion. More specifically, 31 states saw revenue collections fall below projected estimates. Nine states experienced modest revenue gains. Ten states witnessed revenue collections that were “on target” for the fiscal year. Overall, total state general fund revenues were 6% lower than budgeted projections. More particularly, personal income taxes were 9% lower, sales and use taxes were 2.9% lower, and corporate income taxes were 3.7% lower (NASBO, 2004, p. 5).³

There are arguably several reasons or causes for this fiscal crisis. According to McNichol (2003, April, p. 1), the plunge in revenues resulted from several factors including “the effects of the national economic downturn and especially the decline of the stock market, the continuing effects of state tax cuts of the 1990s, the ongoing erosion of state tax bases due to their failure to adapt to the changing U.S. economy, and the effect of federal tax policies.”

In FY 2004, it is anticipated that revenue growth will be, relatively speaking, unexceptional (3 to 5%). According to NASBO, as premised on enacted state budgets for the current operational year, appropriations will increase by 0.2% as compared to FY 2003. The reasons for this are several, including:

• Many states have underfunded pensions.
• Medicaid will continue to grow in the high single-digit rates regardless of significant cuts.
• State tax systems are increasingly obsolete.
• Rainy day funds have been depleted.
• States have already shifted capital expenditures to bond financing from general financing.
• States have already implemented the easy to moderately difficult budget cuts including many one-time reductions and revenue enhancements.
• The federal $20 billion relief package will end in 2004; and there will be little additional help from the federal government due to an increasing federal budget deficit.⁴

State Spending

What can be said about spending during the current fiscal crisis? The most recent Fiscal Survey of States reports that state general fund expenditures have been considerably reduced for both FY 2003 and FY 2004 (NGA/NASBO, 2003, December, p. ix). Growth in state spending in FY 2003 was only 0.6% higher than it was in FY 2002. Based on FY 2003 appropriation acts, expenditures are anticipated to increase a mere 0.2% over FY 2004, representing the most nominal increase in the past 25 years. These minimal increases in state spending stand out particularly when compared to the 8.3% increase, which occurred in FY 2001 over FY 2000, and the 7.2% increase that transpired from FY 1999 to FY 2000.

In FY 2003, state spending “stopgap measures” ran the gamut in order to contend with the burgeoning fiscal crisis. Expenditures, by and large, included sizeable cutbacks in state agency and program budgets (especially administrative costs), draws of surplus and reserve funds, and reductions in workforce by various methods. According to The Fiscal Survey of States, other findings with regard to spending included:

• In FY 2003, 21 states had negative general fund spending compared to the previous year. (In FY 2004, 13 states had enacted negative growth budgets.)
• Forty states reduced FY 2003 enacted budgets by $11.8 billion after they were passed—two states more than the previous year. (Eight states, as of December 2003, have reduced their enacted budgets by $2 billion in FY 2004).
• States continue to rely heavily on cutbacks in spending to balance budgets. In FY 2003, this includes across-the-board cuts (32 states), use of rainy day funds (25 states), employee reductions (16 states), use of early retirement schemes (13 states), and various other spending/cutback strategies.
• Medicaid spending increased by 9.3% in FY 2003. (Thirty-two states are assuming shortfalls will occur at the close of FY 2004).
• The number of FTE’s (full-time equivalent positions) decreased by 0.9% in FY 2003. (Based on appropriations for FY 2004, FTE’s are expected to decrease by an additional 2.8%). (NGA/NASBO, 2003, December, p. ix).

State Revenues  

Though considered some negligible progress from FY 2003, state tax revenue growth in FY 2004 has been described by experts as “stagnant.” The reasons again are familiar ones. Economic recovery, on the whole, has been slow. Outsourcing of jobs has contributed heavily to unemployment. Retail sales have languished, though there have been recent signs of marked improvement in certain instances. Production of durable goods has been flat. And so on.

Despite the implementation of expenditure control strategies and other measures, 36 states passed legislation increasing taxes and fees for FY 2004. These increases totaled $9.6 billion.5 Sales taxes were increased by $2.6 billion, and personal income taxes by $2.3 billion. “Fees” were generously increased as well to offset the FY 2004 fiscal crisis amounting to slightly more than $1.8 billion.

Ohio raised its sales tax, for example, by 1% for two years. Twelve other states increased their sales taxes, either permanently or for a specified duration. Nine states increased their personal income taxes. The greatest enhancement was by the State of New York. Though a temporary measure, the Empire state is expected to raise $1.4 billion for FY 2004. And finally, eight states increased their corporate taxes with the expectation of a cumulative total of $601 million. (NGA/NASBO, 2003, December, p. 11).

It should be noted that large tax hikes were avoided where possible for political reasons. Many tax hikes were associated with “sin” taxes such as cigarette taxes, liquor taxes, and those involving gambling (e.g., state lotteries).

Problems Contributing to the Fiscal Crisis Among States
No one problem can be linked to the present fiscal crisis among states. Experts and observers alike agree that the U.S. economy is the main culprit. But there are contributing or ancillary reasons that have adversely affected state revenues and expenditures. Some of these include revenue estimation uncertainty, expenditure uncertainty, the negative impact of federal policy and actions, an array of exigent court decisions, costly annualizations, the adoption of adverse or ill-conceived state tax policies, and poor budgeting practices. The discussion which follows touches on each of these contributory problems.

Revenue Projection Inaccuracy  

Revenue estimation is an inexact science despite its rigorous and systematic methods and applications. The fluctuations in the market place cannot be entirely foreseen, even based on the best data and use of the best estimating models. Economists, budgeters, and elected officials are abundantly aware of this fact. The bottom line is that too many uncertainties exist. This is especially true at the national level and even more so, experts say, at the state level.⁶

Further, in most cases, sales tax revenues contribute to a large share of states’ general funds (usually a third). Projecting accurately revenue from sale taxes is more difficult than estimating, for example, personal income and corporate tax revenues. This is obviously due to the changeableness or volatility of the market place, i.e., supply and demand. Hence, sales tax predictability is a major culprit of revenue projection inaccuracy.

According to experts, emphasis should be placed on improving revenue estimation by continuously reviewing and verifying data and methods. It is suggested that state forecasters should be proactive and compare other states’ estimate accuracies and the forecasting systems they employ (NASBO, 2004, p. 8).

Expenditure Uncertainty

Estimated or budgeted expenditures are also, in some cases, difficult to pinpoint. If during the budgeted year expenditures exceed expectations, state governments must find ways to close the gap(s). One specific example of this, which has contributed much recently to the fiscal crunch that states find themselves in, is Medicaid.⁷ Medicaid is the U.S.’s largest public health insurance program for the poor. It is jointly funded by federal and state governments.

Medicaid costs have exceeded expenditure projections in many states. The unprecedented rise in the costs of prescription drugs, diagnostic activities, and medical treatment have been the main causes.⁸ In FY 2001, for instance, the states’ contribution to Medicaid escalated by 10.6%, equating to a $4.4 billion jump above states’ budgeted estimates. In FY 2002, Medicaid grew by 13.6% and exceeded budgeted estimates by $2.8 billion.⁹

The Impact of Federal Tax Policy, Sending, and Mandates  

Federal tax policy, spending, and mandates can cause ripple effects on state revenues and expenditures. In many instances these ripple effects can and do have negative consequences for states. First consider the impact of federal tax policy on states.

The vast majority of state tax codes are closely linked with federal income laws. Many states, like that of South Carolina, configure their personal income tax on federal adjusted income. In some cases, states calculate their personal income taxes as a percentage of federal income tax liability. As such, any adjustments to federal tax policy or law can “automatically” affect state personal income tax and their resultant revenues (NASBO, 2004, p. 9). For example, the phase-out of the federal estate tax will cost several states an estimated $4 billion by the end of the year 2005.

Federal spending too impacts states—their revenues and spending. In FY 2001, federal grants and other U.S. financial aid to states amounted to almost 29% of all state spending. Two problems contributing to federal assistance to states are spending cycles and diminishing state allotments. First, the federal fiscal year begins in October, while most states begin their fiscal year in July. Thus, state budgeters must estimate or “guess” as to the amount of federal revenue expected. This creates uncertainties and often shortages in federal aid result. Second, with federal spending increasingly concentrated on national security and defense, fewer federal dollars are expected to be allotted to states.

Lastly, unfunded federal mandates cost states billions of dollars each year. While the Congressional Budget Office is required to identify any unfunded federal mandates above $58 billion, still federal laws are passed with price tags that are unmet, in part or whole, by federal dollars. This is especially true with regard to mandates pertaining to education and election laws (NASBO, 2004, p. 9).

Court Decisions, Voter Referenda, and Catastrophic Occurrences  

Three separate and distinct areas have, on some occasions, contributed to the current fiscal crisis among states. These areas include unpredictable court decisions, voter decisions, and “disastrous events.”

Federal and state court decisions often impact, in some way, either state revenues or spending. Many court cases involve questions of legality as to state tax codes and taxpayer compliance. A “negative” decision of the judiciary as relates to the tax code (or state regulations), for instance, can be costly to state government. Further, court decisions are not uncommon with regard to legal issues pertaining to “the treatment of corporate income, taxation of out-of-state firms or businesses, educational funding (e.g., questions of equity), and state costs associated with care for the disabled or mentally ill” (NASBO, 2004, p. 10). In all these cases, state budgets may be adversely affected.

A number of states permit voter initiatives and referenda. California, for example, is a state that has experienced serious budget woes, and in a few cases, voter initiatives have been contributory, directly or indirectly, to these fiscal problems. A recent illustration of a voter initiative and its affect on state costs occurred in Florida. Voters approved an initiative reducing K-12 class size. This obviously cost the State of Florida more money for teachers, classroom facilities, etc. The result was that the budget was out of balance by several millions of dollars.

States and their finances are affected as well by calamitous events such as those associated with terrorism, like New York’s September 11th aftermath, and natural disasters like damage caused by hurricanes (e.g., Hugo, Andrew, and Fran). Hurricane Fran in 1996, for example, cost three states (mostly North Carolina) some $3.4 billion.¹⁰

Annualizations  

Annualizations limit the fiscal discretion of the governor, the legislature, and budgeters. Annualizations are defined as recurring items currently funded with non-recurring dollars or capital items with multi-year funding requirements. Annualizations also can be items resulting in the loss of revenue, or items partially funded in one fiscal year which must be fully funded the next fiscal year (Young, 2000, p. 53).

Annualizations have been problematic for a number of states, particularly South Carolina, New York, Oklahoma, Illinois, and California. For example, the South Carolina executive budget for FY 2005 proposed a reduction of one-time expenditures to $144 million. This is a substantial improvement from FY 2000. Then annualizations for the Palmetto state were $564 million. Over the past four years, South Carolina’s governor and the legislature have worked diligently to lower the cost of annualizations; thus, diminishing—to the extent possible—the impact of the current $350 million funding gap.

Incremental Tax Policies  

The criteria for a “good” tax system are much discussed in the literature. The most significant criteria are efficiency and equity. Other criteria include balance, stability (as regards both “policy” and “revenue”) and ease of compliance.¹¹

Unfortunately, it is commonly acknowledged that state tax laws and regulations are often altered without the benefit of a thorough analysis using the above criteria. The outcome is usually one that skews the tax code in favor of special interests leaving state revenue coffers short changed. Sales tax exemptions on certain products and especially services are illustrative of this phenomenon. Another source of frequent reductions in revenue, due to special interests, are corporate incentives and perks that are used to entice corporations and businesses to headquarter or locate within state borders. Generally, the political popularity of tax reductions, of any sort, have consistently eroded tax bases and, in many cases, caused imbalances in state tax structures. The long-term results of ill-conceived and incremental tax changes to state law have invariably contributed to the fiscal crisis that many states are now confronting.

Inadequate Budget Practices  

Inadequate, dated state budgeting methods and practices have long been pointed to as important causes of both past and present fiscal crises. In part, this inadequacy in many states is caused by what experts term “the archaic line-item approach” to budgeting (Young, 2001, pp. 45-46). This budget approach is typically recognized as one that deals strictly with inputs or resources required to operate and maintain governmental entities and their services. It lists, line-by-line, proposed expenditures, such as personnel, equipment and supplies. This itemization may be quite detailed and list actual position allocations and budgeted objects-of-expenditure such as telephone costs, travel, computers, vehicles, postage, books, etc. (Young, 2001, p. 18).

In conjunction with this simplistic and dated budgeting approach is the problem of “incrementalism.”  Incrementalism is the approach of making budget decisions, using limited information and data, within the scope of “new monies” only (i.e., within the new, additional funds that are projected above the previous year’s appropriated revenue base). In this way, the previous year’s budget serves as a starting point and remains essentially unexamined for budgeting purposes. Budget focus and decisions are therefore confined to narrow, marginal budget decisions within the framework of circumscribed new dollars (Young, 2001, pp. 10-11).

The inadequacies here, so say many budget experts, are plain. Information and data on state agency or programmatic goals and objectives, performance (efficiency and effectiveness), and related statistical trends are nonexistent. Further, attention and decision-making are given only to the base budget. Given these inadequacies, budgeting methods and practices are, by their very nature, recognized as being “causative” to the fiscal woes of states. The solution, according to some specialists in budgeting techniques, appears to be the development and use of performance-based budgeting methods and zero-base techniques.

Spending Priorities
The literature identifies four major spending areas among the states. These spending areas are “priority” spending areas for states and their costs have accelerated significantly for the past several years. They include elementary and secondary (K-12) education, higher education, Medicaid, and corrections.

K-12 Spending 

State governments experienced momentous growth in educational spending from FY 1996 through FY 2001. According to the Education Commission on States, per student spending for this period exceeded inflation by 13%. However, in FY 2001, by comparison, the fiscal crisis among states began to impact K-12 spending, marking a measurable decline in educational spending over FY 2002 and FY 2003.¹²

For example, though the National Conference of State Legislatures predicted a 4.8% increase in educational spending for FY 2003, because of state revenue shortfalls, 27 states cut their education budgets to close budget gaps. California cut K-12 spending by $2.4 billion, and many school districts in Oregon had to reduce their school year up to 25 days, as was the case in the City of Portland. Other states’ actions as regards educational spending countermeasures included: Michigan, $127 million in cuts; Minnesota, $26.9 million in cuts; Washington, $545 million in cuts over two years; Connecticut, a 5% reduction in education spending; Georgia, three rounds of cuts (Griffith, 2004, March, p. 1).

More recently, however, there is some encouraging news. “In a survey of the 16 states comprising the Southern Regional Education Board, it was discovered that 14 have enacted budgets that have increased spending for K-12. Specifically, 11 states have made increases under 3%, and three states expect increases greater than 5%.”¹³

For FY 2004, according to NASBO, overall state general fund spending is expected to grow 1.5%. With educational earmarked funds expected to grow 5%, the total state growth for educational spending is anticipated to be 1.9% at the conclusion of FY 2004.

Higher Education  

State-supported institutions of higher learning have especially suffered from the cyclical economic downturns of recent years. With fewer state revenues available, and the increasing (and competing) demands of K-12 public education and Medicaid costs, state colleges and universities have invariably relied on hefty tuition increases. With roughly 75% of all college students in the U.S. attending public higher-education institutions, the Brookings Institution has called the effects “profound” (Kane & Orszag, 2003, September, p. 1).

In FY 2002, for example, state government spending on higher education was the third largest expenditure area/category. State funds utilized for higher education purposes totaled $106.1 billion, representing approximately 14% of all total state monies spent (Boyd, 2002, October, p. 2). “Additionally, more than 25 state colleges or university systems increased their tuition between 10 and 20%. Four colleges raised tuition by more than 30%, according to a recent survey conducted in the fall of 2003 by the National Association of State Universities and Land-Grant Colleges.”¹⁴

Even though a trend of sharp tuition increases has marked the fiscal crisis and its impact on public higher education, state appropriations have not—in many cases—filled the severe funding gaps. Thus, since the late 1970s there has been a decline in public higher education spending per FTE student as compared to private institutions. For instance, figures indicate the ratio dropped from 70% to near 58% in 1996. Much of the decline occurred in the early 1980s, the recession of the early 1990s, and over the past couple of years.

The results of such occurrences have of course affected the quality of public higher education. Public institutions have lost many superior academic students to private colleges and universities. Faculty salaries have declined at public institutions. Classes and academic programs have been cut back or cancelled. A survey of faculty members at research and doctoral institutions of higher learning by the U.S. Department of Education, found that it was commonly believed that public colleges and universities were generally in a state of decline (Kane & Orszag, 2003, September, p. 5).

Medicaid Spending  

Medicaid costs have increased considerably over the past few years, contributing to the recent fiscal crisis among states. In FY 2002, for example, total expenditures for Medicaid were $258.2 billion. The state share of this total was $111.6 billion. This was a 12.8% increase over the previous year. Medicaid spending for FY 2003 increased by an additional 9.3%. Percentage-wise, Medicaid costs—on the average—comprise about 20% of all state general funds (NGA/NASBO, 2003, December, p. 4).

FY 2004 Medicaid budgets show an expected increase of 4.6%. Experts believe generally, like the previous years’ estimates, that this percentage is likely to be too low by fiscal year’s end. According to the NGA/NASBO (2003, December, p. 5) most recent fiscal survey of states, 32 states already “assume a shortfall in their FY 2004 Medicaid appropriations.”

In FY 2003, Medicaid provided health insurance to 40.4 million low-income persons. Medicaid expenditures covered, for example, institutional and nursing home care, hospital care, prescription drugs, health and community care, and physicians and other medical practitioners. Like private health insurance costs, Medicaid expenditures are increasing significantly in line with rising general health care costs nationwide.

Cost-containment measures taken by states over the past three years, however, have helped temper Medicaid expenses a bit. Some of the measures include reducing or freezing provider payments, requiring prior authorization for drugs or using preferred drug lists, restricting Medicaid eligibility, reducing benefits, and increasing co-payments. (NGA/NASBO, 2003, December, p. 6).

Corrections Spending  

The National Conference of State Legislatures reports that state correctional facilities held 708,000 prisoners in 1990. By 2000, the state inmate population had increased by an additional 537,000 persons or 76%. Over a period of a decade (1992-2002), state governments built new correctional facilities totaling 742,000 additional beds.¹⁵

Corrections’ spending was the second fastest growth area for state general funds during the 1990s. Much of this resulted from two factors: 1) state adoption of “three strike” laws, and 2) the approval of “truth in sentencing” laws.16 In short, these laws lengthened sentences and the results have been significant increases in state prisoners, and requirements for additional correctional spending.

Between 1985 and 2000, state correctional spending increased from $10.7 billion to slightly more than $20 billion. Overall, depending on the state, spending on corrections doubled and in some cases tripled during this 15-year period. States with high crime rates were disposed to have higher spending requirements on correctional needs. In 1999, for example, this included the states of California, Alaska, and Delaware (U.S. Dept. of Justice, 2002, February, p. 6). These states, and others by a lesser degree, have seen correctional spending consistently add to their fiscal crisis, especially in fiscal years 2001 and 2002.

Budget Stopgap Measures and Other Remedies
States have done virtually everything that can be reasonably done to contend with the many budget deficits which have occurred over the past two or three years. There have been targeted budget cuts and across-the-board cuts. Rainy day or reserve funds have been tapped. Cigarette taxes have been raised, some considerably so. Tobacco settlement money has been spent. The restructuring of state agencies and programs has been utilized for purposes of cost savings and spending reductions. In essence, state governments closed the budget gaps as best they could, at least for the short-term, with expectations that the future will be brighter.

Cut Spending  

To contend with the recent fiscal crisis, states have regularly cut spending, either by targeted cuts or across-the-board cuts. While targeted cuts have honed in on low-priority programs primarily (and reluctantly, on occasion, high priority programs as well, such as education), across-the-board cuts are the norm. Across-the-board cuts are, according to experts and practitioners alike, the simplest and easiest way to reduce budget deficits. This is especially true when there is little time or resources available to make targeted cuts. Still, one benefit of across-the-board cuts is that state agencies are better informed to cut where they think best, as opposed to governors and legislators, who often lack the depth of information necessary to cut or reduce spending for specific programs.

Statistically, what are states’ actions with regard to balancing budgets using cuts? For FY 2004, for example, 31 states have cut spending. Across-the-board cuts were utilized by 14 states. Minnesota imposed a 15% spending cut among its state agencies, while at the other spectrum, Texas required a “modest” cut of 1.5% across-the-board. In addition to these broad budget cuts, some targeting of cuts was undertaken by a number of states. These included spending cuts to Medicaid, K-12 expenditures, and corrections (NCSL, 2003, p. 6.).

Tap Existing Special Funds  

State governments generally have a number of special funds dedicated for specific purposes. There are often special funds, for instance, for emergency and insurance needs, maintenance purposes, and “trust funds” to meet earmarked conservation and transportation requirements. Recent data, for FY 2004, indicate that 29 states tapped special or dedicated funds to help offset budget shortfalls.

Florida drew on a number of special funds generating $726.8 million. Maryland found $328.7 million from special sources, as did Iowa, which transferred fund balances and interest earnings amounting to approximately $52 million. Other states tapping special funds include South Carolina ($40.1 million), Minnesota ($23 million), and Hawaii ($75 million). (NCSL, 2003, p. 6).

Initiate Work Force Reductions, Caps, and Freezes  

The fiscal crisis among states has spurred many state governments to undertake measures that affect state employment and workers. These workforce cost reduction measures are logical given that a large portion of state spending goes for employee salaries and benefits. Hence, many state governments have laid off workers, capped employment, instated hiring freezes, reduced or eliminated unfilled FTE positions, and provided early retirement incentives.

Twenty-three states have taken some workforce measure(s), in FY 2004, to deal with the prevailing financial crisis. By way of illustration, 11 states laid off workers, three of which affected 1,000-plus state employees. Eleven states implemented hiring freezes. Further, worker salaries were frozen in nine states and four states made use of employee furloughs (NCSL, 2003, p. 6).

Draw on Rainy Day Funds  

Currently, 47 states have established “rainy day” funds. These stabilization funds are set-aside reserves or accounts that are used to offset budget shortfalls. The median rainy day funds equal about 4.5% of a state’s general fund revenue for the previous fiscal year.

In the mid-to-late 1990s, during the economic growth surge, rainy day reserves appreciated to their highest levels in 20 years. At the conclusion of FY 2000, states total balances, which included general fund and rainy day balances, totaled nearly $50 billion. However, over FY 2001 and FY 2002, many states were forced to tap their rainy day funds to contend with the marked revenue deficits.¹⁷

In FY 2004, the number of states utilizing rainy day reserves “has dropped” to 13 states. The causes are generally two-fold. First, states have reduced budget balances considerably through other stopgap measures, thus reducing the necessity of tapping reserves. Second, in some cases, rainy day funds have simply been depleted over the past two fiscal years. Arizona, Oklahoma, and Idaho are states that have tapped out their reserves. Texas, for example, completely depleted its rainy day fund amounting to $811 million. Other states have made substantial withdrawals. These states include Alaska ($479.2 million), Indiana ($214 million), Florida ($143.5 million), and Georgia ($143 million). (NCSL, 2003, p. 7).

Use Tobacco Settlement Funds  

Forty-six states settled their lawsuits against tobacco companies to recoup costs associated with related health care costs in late 1998.¹⁸ These settlements required that tobacco companies make annual financial allotments to states in perpetuity. Total settlements to states for the first 25 years are expected to be approximately $246 billion.¹⁹

Though states were originally intent on spending tobacco settlement funds to redress health costs associated with the ills of smoking, some states have tapped the tobacco settlement funds for other purposes, mainly as stopgap measures to deal with the recent deficit situation. For example, “only eight states are funding tobacco prevention programs at even half the minimum levels recommended by the U.S. Centers for Disease Control and Prevention (CDC). Thirty-three states are spending less than half the CDC’s recommended minimum amount. Another five states –Michigan, Missouri, New Hampshire, South Carolina, and Tennessee—and the District of Columbia allocate no significant state funds for tobacco-use prevention or health costs.”²⁰

The reorganization of state agencies and programs can eliminate duplication of effort, overlap, and governmental waste. In short, reorganization of state government can save significant monies. Many states have recently initiated restructuring measures to help diminish the current fiscal crisis. West Virginia, for instance, has proposed streamlining a maze of 257 distinct programs serving children and families. West Virginia has also proposed merging two IT agencies that will result in saving an estimated $1 million.²¹ Similarly, Texas state representative David Swinford introduced a 400-page restructuring bill during the 2003 legislative session that was expected to aid in “plugging the state’s $10 billion deficit.”²² Additionally, California’s new governor, Arnold Schwarzenegger, has proposed a comprehensive reorganization plan to reduce state spending and improve accountability.²³

South Carolina’s governor, Mark Sanford, has also recommended a broad-based restructuring of state government. Governor Sanford’s FY 2005 budget proposes a 17% reduction in the number of state agencies (from 87 to 72), with the potential of millions of dollars in savings (roughly $26 million).

According to the American Legislative Exchange Council and Manhattan Institute for Policy Research, “hundreds of billions of dollars’ worth of state-owned enterprises and assets have been sold or leased to the private sector” (Eggers, 2002, July, p. 7). This includes state surplus lands and facilities, ports, and stadiums. The result has been a cost-savings to taxpayers and a viable way to deal with state deficits.

Further, based on research by the noted Reason Foundation,²⁴ though somewhat dated, cities and states have over $226 billion in assets which could be sold. “Selling off or leasing state-owned assets allows antiquated or dormant infrastructure to be cashed in for much needed state spending” (Eggers, 2002, July, p. 7). In the 1990s, Michigan sold its accident fund, and New York sold its port authority. The State of California sold surplus property, land and facilities, in the 1990s as well, earning some $200 million.

The most-productive privatization efforts by states have been the sale of workers’ compensation funds. Michigan, as mentioned above, sold its workers’ compensation (accident) fund in 1993 to Blue Cross/Blue Shield for $255 million. Nevada is another state which privatized its workers’ compensation fund (Eggers, 2002, July, p. 7).

Experts in state budgeting and financial matters have argued in modern times that state appropriations should be based on performance. In this respect, state agencies and programs that have good or excellent performance records, that demonstrate positive outcomes or results, should be given priority in funding decisions. Those governmental units or programs that perform less than satisfactory should have their funding reduced or possibly eliminated altogether. During a period of fiscal shortfalls, experts believe that states should rely on performance-based budget systems in order to ensure that successful agencies and programs receive the lion’s share of limited state revenues.

Generally speaking, experts define a performance budget as one that identifies programmatic activities and then allocates or “links” funds to these activities in the form of per unit measurements. Additionally, performance budgets often gauge the accomplishment of program objectives. This first measurement or “cost per units” of activities or services relates to what is called program “productivity” or “efficiency.” The latter measurement, the meeting of program objectives, is commonly termed “effectiveness.”

Most states are actively involved, to one extent or another, in reforming their budgeting procedures and practices. Budgeting experts have recognized several of these states as model approaches in the utilization of performance-based budgets. Those frequently mentioned are Texas, Oregon, Minnesota, Virginia, and Florida. More recently, Iowa and Missouri have been given high marks in their efforts at improving state budgeting methods.

Pay for Performance  

Most compensation systems for state employees are outdated and pay employees strictly with relation to predetermined pay (“class and comp”) scales. Pay increases are generally across-the-board increments, step-increases, COLAs, and are sometimes based on salary levels or seniority. Though pay for performance is occasionally witnessed among progressive states, still there is very little attention in the main given to rewarding excellence of performance among industrious and innovative state workers.

Contrarily, pay for performance is “a given” in the private sector. Employees realize that their salaries are driven by performing well, contributing to the company’s sales, and providing quality, needed products and services. Private companies and businesses create a culture of rewards and incentives for employees to perform their jobs with emphasis on efficiency, effectiveness, and productivity.

Experts in public administration recommend that state pay systems be directly tied to performance. Performance evaluation or appraisal instruments should be developed that encourage and recompense state workers who achieve agency or programmatic goals and objectives, are attentive to customer or client needs, and exceed stated performance standards. In this way, so believe experts, state governments can attain maximum results, save money, and ultimately diminish the impact of cyclical fiscal downturns.

Use Technology to Reduce Overhead 

Experts appear, on the whole, to be certain that states which invest in IT equipment and processes can realize positive tangible results—cost-savings, and more accessible and convenient state services. Reasons for this are plentiful and demonstrable in the private sector. It is reported that Cisco systems is profiting by some $825 million annually through e-commerce savings. Also, IBM claims to save $1 billion annually by using the Internet to conduct much of its business affairs (Eggers, 2002, July, p. 13).

Though such savings are more difficult to pinpoint in IT applications for state government, some evidence exists that confirms that IT can be beneficial—financially—to cash-strapped states. Kentucky, for example, has calculated that using IT innovations, particularly for the provision of Web-based services to the public, saves the state roughly $140 million a year. Such state-operated IT or Web-based applications include the filing of tax returns, the purchasing of permits, registering corporations, procuring support equipment and supplies, and so on (Eggers, 2002, July, p. 13).

Generally speaking, in what ways can “e-government” save states money? These would include 1) reducing paper and printing costs, 2) getting better prices on goods and services, 3) reducing workforce costs, 4) lowering travel and training costs, 5) reducing processing costs, and 6) reducing document storage requirements.

Tax Actions
Data show that many states raised taxes and fees in FY 2003 as they had done so, under similar circumstances, the previous fiscal year. Total new, additional revenue from tax actions in FY 2003, affecting FY 2004 monies, is expected to be nearly $7 billion. Add to this an extra $3.7 billion raised in fees, and the grand total is some $10.7 billion. This equates to a 1.3% boost over the prior fiscal year (NSCL, 2003, p. 7).

With 42 states reporting to a recent survey by NCSL, Hawaii was alone in cutting taxes by more than 1%. Conversely, 17 states increased their taxes by greater than a percentage point. Four states—Idaho, New York, Ohio, and Delaware—raised taxes by 5% or more. The largest gain was realized by Alabama, which raised taxes overall by 9%. Lastly, 24 states made little or no noteworthy tax changes (NCSL, 2003, p. 7).

Personal Income  

Taxes Personal income taxes were raised in ten states. Six states lowered their personal income taxes. The State of New York raised personal income taxes most, totaling $1.7 billion. More modest increases, relatively speaking, were enacted by Arkansas ($56 million) and similarly Maryland ($52 million). In the former case, legislators added a 3% surcharge to income tax bills, and in the latter, a change in income tax withholding requirements netted an increase. Other adjustments to personal income taxes netting increases to tax revenues include:

• North Carolina reduced the age requirements of a child from 23 to 16 to qualify for the childcare credit.
• Virginia and Kentucky abolished deductions for foreign earned income.
• Missouri eliminated the deduction for railroad annuities and, additionally, taxed the casino winnings of nonresidents (NCSL, 2003, p. 7).

With regard to those states lowering personal income taxes, for example, Hawaii cut $44 million by phasing in rate reductions. Similarly, New Mexico lowered taxes by $17 million by beginning a five-year income tax reduction process. And Montana decreased personal income taxes by simply adjusting its tax rate tables.

Sales and Use Taxes

To balance budgets, 17 states increased their sales taxes, through varying adjustments in tax law, in FY 2003. These changes in sales and use taxes will affect revenue for the current operating year (FY 2004). Those states cutting sales taxes were four—Minnesota, Texas, Georgia, and West Virginia.²⁵

The sales tax in Ohio was increased from 5% to 6% and is expected to net roughly $1.4 billion. Other tax actions affecting sales collections include:

• New York raised their general sales tax by one quarter of a percent. New York also eliminated the sales tax exemption on clothing for the next two years.
• North Carolina and Nebraska approved a continuation of a temporary sales tax rate increase.
• Though no general sales tax is levied in Montana, it did place a sales tax on lodging and car rentals.
• Rhode Island raised its sales taxes by 1% on food.
• Washington raised its sales tax on cars and trucks by .3% (NCSL, 2003, p. 8).

Some states increased their corporate and business taxes in anticipation of bringing in a cumulative or net $486 million. Specifically, eight states raised their corporate taxes and four reduced them.

New York raised its corporate taxes by $237 million. This increase was atypical of recent tax actions in New York, a state which has cut corporate taxes over the several past years. Also, Delaware raised corporate taxes by $90 million by adjusting its franchise tax statutes. Finally, corporate tax loopholes were closed in Massachusetts and Illinois, while Ohio altered its legal definition of a “business.” In all these cases, the results were increased corporate revenues for the states (NCSL, 2003, p. 8).

Those states reducing corporate taxes were Florida, Georgia, Washington, and Mississippi. Florida and Georgia made the largest cuts. Florida enhanced its tax credit for corporate contributions to scholarship funding organizations. Georgia provided for additional tax credits to corporations and businesses for job creation.

Several states made changes to miscellaneous other taxes, such as those taxes associated with health care providers, cigarette and tobacco, motor fuel, and alcoholic beverages. The largest tax increases were those related to cigarettes and tobacco, netting an overall $642 million. In all, 15 states raised cigarette taxes. Additionally, motor fuel taxes were increased by $339 million. States raising fuel taxes were Maine, Kansas, North Carolina, Ohio, Washington, and West Virginia.

Health care provider taxes were raised in eight states, providing an additional net increase of $205 million. Four states raised taxes on alcoholic beverages ($22 million). Other “miscellaneous” tax increases among the states equal a total net increase of $557 million in revenues for the current operating year (NCSL, 2003, p. 9).