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NEW YORK TIMES

In report on states' finances, a grim long-term forecast

By Mary Williams Walsh and Michael Cooper
New York Times

POSTED: 01:30 a.m. HST, Jul 18, 2012

WASHINGTON >> The fiscal crisis for states will persist long after the economy rebounds as states confront financial problems that include rising health care costs, underfunded pensions, ignored infrastructure needs, eroding revenues and expected federal budget cuts, according to a report issued here Tuesday by a task force of respected budget experts.

The severity of the long-term problems facing states is often masked by lax state budget laws and opaque accounting practices, according to the report, an independent analysis of six states released by a group calling itself the State Budget Crisis Task Force. The report said the financial collapse of 2008, which caused the most serious fiscal crisis for states since the Great Depression, exposed a number of deep-set financial challenges that will grow worse if no action is taken by national policymakers.

“The ability of the states to meet their obligations to public employees, to creditors and most critically to the education and well-being of their citizens is threatened,” warned the two chairmen of the task force, Richard Ravitch, the former lieutenant governor of New York, and Paul A. Volcker, the former chairman of the Federal Reserve.

The report added a strong dose of fiscal pessimism just as many states have seen their immediate budget pressures ease for the first time in years. It also called into question how states will be able to restore the services and jobs that they cut during the downturn, saying that the loss of jobs in prisons, hospitals, courts and agencies had been more severe than in any of the past nine recessions.

“This is a fundamental shift in the way governments have responded to recessions and appears to signal a willingness to ‘unbuild’ state government in a way that has not been done before,” the report said, noting that court systems had cut their hours in more than a dozen states, delaying actions including divorce settlements and criminal trials.

The report arrived at a delicate political moment. States are deciding whether or not to expand their Medicaid programs to cover the uninsured poor as part of the new health care law — an added expense some are balking at even though the federal government has pledged to pay the full cost for the first few years and 90 percent after that. Many public-sector unions feel besieged, as states and cities from Wisconsin to San Jose, Calif., have moved to save money on pensions. And Washington’s focus on deficit reduction — and a series of big budget cuts scheduled to take place after the fall election — has made cuts to state aid inevitable, many governors believe.

If federal grants to the states were cut by just 10 percent, the report calculated, the loss to state and local government budgets would be more than $60 billion a year — which it said would be nearly twice the size of the combined tax increases that states enacted from 2008 to 2011 in response to their deepest fiscal crisis in more than 50 years.

Things are worse than they appear, the report contends.

Even before the recession, Medicaid spending was growing faster than state revenues, and the downturn has led to even higher caseloads — making the program the biggest single share of state spending, as many states have cut aid to schools and universities.

States do not have enough money set aside to cover the health and retirement benefits they owe their workers. Important revenue sources are being eroded: States are losing billions of sales tax dollars to Internet sales and to an economy in which much consumer spending has shifted from buying goods to buying lightly taxed services. Gas tax revenues have not kept up with urgent infrastructure needs. And distressed cities and counties pose challenges to states.

While almost all states are required by law to balance their budgets each year, the report said many have relied on gimmicks and nonrecurring revenues in recent years to mask the continuing imbalance between the revenues they take in and the expenses they face in the short term and long term — and that lax accounting systems allow them to do so. The report focused on California, Illinois, New Jersey, New York, Texas, and Virginia, and found that all have relied on some gimmicks in recent years to balance their budgets.

California borrowed money several times over the past decade to generate budget cash. New York delayed paying income tax refunds one year to push the costs into the next year and raided state funds that were supposed to be dedicated to the environment, wireless network improvements and home care. New Jersey borrowed against the money it received from its share of the tobacco settlement and, along with Virginia, failed to make all of the required payments to its pension funds. Texas delayed $2 billion worth of payments by a month — pushing those expenses into the next fiscal year. Illinois has billions of dollars of unpaid bills and borrowed money to invest in its severely underfunded pension funds.

When desperate budget officials go looking for money to balance their budgets, they often see public pension funds as an almost irresistible pool of money. One common way of “borrowing” pension money is to not make each year’s required government contribution. Most places use actuaries to calculate how much money they must set aside each year to cover future payments — a number known as the “annual required contribution.” But despite the name, there is usually no enforceable law that the state or locality must pay it.

As a result, the task force found that from 2007 to 2011, state and local governments had shortchanged their pension plans by more than $50 billion — an amount that has nothing to do with the market losses of 2008, which caused even more harm.

When money is withheld from a pension fund, the arrears can start to snowball, because most states count on the money compounding at a rate of about 8 percent. Eventually the unfunded liability grows unmanageable, given all the other fiscal pressures on states and cities.

In addition to pensions, America’s states and municipalities are estimated to have promised well more than $1 trillion in health benefits — that most have not started saving for — to their retirees. (The health costs became apparent only a few years ago, when an accounting rule was changed.)

Ravitch became deeply concerned about the fiscal problems of the states in 2009, after he won an emergency appointment as New York’s lieutenant governor during that year’s budget impasse. As he dug into financial records to devise a fiscal plan, he said, he began to see the extent to which officials had been using one-offs and accounting gimmicks year after year to make the budget seem balanced. His plan was rejected.

Ravitch spent the remainder of his 17-month term investigating New York State’s finances on his own and trying to compare what he found with the problems emerging in other states. But he could not find what he considered an adequate source of information to document the problem, so he and Volcker decided to raise money to create one of their own. Last week, Ravitch was in Washington, presenting the task force’s initial findings and recommendations to Treasury Secretary Timothy F. Geithner, Federal Reserve chairman Ben S. Bernanke, and others.

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