States Squander the Great Economy

Member Group : Lincoln Institute

Unemployment in the United States is approaching historic lows and our economy is unarguably a full employment economy.

Consumer confidence and personal consumption expenditures have improved since 2009, business investment and sentiment have improved, and net exports are improving partially in light of renegotiated trade agreements.

With three of the four components of gross domestic product stabilizing significantly, only government spending and deficit financing are questionable components of the economy.

State tax revenues from higher income taxes in an improving economy and increasing sales taxes due to increasing consumer spending should be expected to produce massive state surpluses. This hypothesis, if validated, would signify that the United States is potentially on the road to financial recovery for all components of the economy with the exception of the federal deficit.

The primary sources of income for most states are income taxes, sales taxes and property taxes.  In a 2017 report from PEW Trust using data from the National Association of State Budget Offices (NASBO) indicates that 31 states are facing budget shortfalls and the rainy day funds of most states are woefully inadequate or even nonexistent to withstand a recession.  All of this is despite the improving national economy.

Unfortunately, concurrent with the increasing revenues for the states, spending has also continued to explode resulting in limited to no improvement in the financial condition at the state level.  The implication is that states are spending all the increased income that is coming in from the improving economy with no measurable improvement in the states’ financial condition.

This lack of long-term financial planning is a recipe for disaster!

To get a comprehensive perspective of the condition of states finances requires an individual with significant financial expertise to sort through the CAFR – Comprehensive Annual Financial Report.

This massive document is now required for all public entities. All states prepare this annual report. The machinations and complexity of state financial reporting and the requirement to balance the budget by whatever means hides the real risks and spending excesses by the states.

Despite the CAFR’s intended purpose of improving clarity in state financing, the ability of states to use special funds, record unrealistically high expected earnings rates on pension obligations, use debt financing to skim over budget deficits, and failing to record postemployment health care cost of state retirees all limits the validity of this financial report.

Efforts are underway such as with GASB 75, which requires recording of post-employment benefits, to improve financial reporting but a great deal must yet be done.

Upon examination of the comprehensive annual financial reports for the majority of the states it becomes painfully apparent that the states have squandered a substantially improving economy by increasing spending rather than by improving their financial condition.

Complicating the analysis is that governments financial reports still fail to adequately disclose financial condition. This lack of transparency helps mask the severity of the crisis.  For instance, in Pennsylvania the governor celebrated transferring $22 million into the rainy-day fund despite borrowing $1.5 billion in order to fund the payment.

This failure to substantially replenish rainy day funds, pay down pension obligations, pay down debt and to prepare for a future recession will wreak havoc during the next recession. I would anticipate that states such as Illinois, Connecticut, New Jersey, Pennsylvania, and California will find themselves in need of federal bailout or they will become insolvent.

Only by improving transparency, limiting state government spending growth, and reporting state debt service exclusive of the operating budgets of the states will states began to come to grips with the financial crisis that they are in.

The tremendous improvement in the economy since 2016 should begin to result in reduced social expenditures due to the improved economy but it has not.  Instead states have continued increasing spending for virtually every component of the budget including social safety net programs.

Just as in 2000, we found out that earnings do matter. In 2008, we came to understand that no documentation loans were unsound at every level.  In 2018, we have to recognize that no state is too big to fail.

In 2000 the tech industry led a financial crisis. In 2008 the housing industry and an out-of-control financial industry led us into a near depression.

In 2018, states that fail to heed their financial responsibilities to their citizens and to our nation may well lead us into a financial disaster of unparalleled proportions.

Transparency, spending reductions, and reducing debt service will keep our nation from falling victim to financially irresponsible state fiscal budgets. It is not too late for the states to live up to their responsibilities to us all.

Frank Ryan, CPA, USMCR (Ret) represents the 101st District in the PA House of Representatives.  He is a retired Marine Reserve Colonel, a CPA and specializes in corporate restructuring.  He has served on numerous boards of publicly traded and non-profit organizations.  He can be reached at [email protected].