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OCR for page 284
State Fiscal Conditions
STEVEN D. GOLD
The fiscal condition of state governments is a critical factor in
determining how much aid states can provide to local governments.
State fiscal conditions have been volatile over the past decade. The
finances of most states were generally healthy in the late 1970s,
but they deteriorated significantly in the early 1980s; they began to
recover in 1983. Although most states are still considerably better
off than they were in the depths of the recessions of the early 1980s,
their fiscal conditions are generally not as strong as in the late 1970s,
in part because of the legacy of the tax revolt, which in a number of
states limits the reserves they are able to maintain.
This report consists of four parts: (1) a discussion of various
measures of state fiscal conditions; (2) descriptions of state fiscal
conditions in recent years and the fluctuations that have occurred in
state tax levels; (3) an analysis of state aid to local governments; and
(4) the conclusion of the report, a discussion of future prospects for
state fiscal conditions and local aid policies.
The views expressed in this paper are solely those of the author and do
not reflect the official position of the National Conference of State Legislatures,
for which he serves as director of fiscal studies.
284
OCR for page 285
STATE FISCAL CONDITIONS
MEASURES OF STATE: FISCAL CONDITIONS
285
The two most widely cited measures of state fiscal conditions
are the surpluses (or deficits) of state and local governments as esti-
mated by the U.S. Department of Commerce's national income and
product accounts and the year-end general fund balances for state
governments as reported annually by the National Conference of
State Legislatures (see, e.g., Gold et al., 1985) and the National Gov-
ernors' Association/National Association of State Budget Officers
(1986~. A third measure is the financial assets held by states.
The Commerce Department's national income and product ac-
counts (NIPA) estimate the operating surplus or deficit of state and
local governments, usually on a combined basis but intermittently
on a separated basis. Because this report is concerned with state
finances, we will consider only the surplus or deficit statistics for
state governments alone. The NIPA estimates cover all state govern-
ment activities, including those of independent or quasi-independent
institutions established by states. The estimates aggregate all state
balances into a single number; they represent flows during a specific
period of time, and they do not consider funds raised by borrow-
ing as revenue, although they count expenditures financed by the
borrowing.
NIPA data are reported both to include and to exclude social
insurance funds. Although these funds always have a large surplus
because money is being accumulated to provide future pension ben-
efits, they are not available to fund current services. Thus, while it
is appropriate to include social insurance funds in macroeconomic
analyses, they should not be considered when measuring short-run
state fiscal conditions. This distinction is important because the sur-
plus in the social insurance funds invariably dwarfs the remaining
surplus. In 1985, for example, the total NIPA surplus for state and
local governments was $59 billion, of which the social insurance funds
surplus accounted for $52.9 billion (Levin and Peters, 1986~.
The general fund is the account into which most state tax rev-
enue is deposited and from which most current spending is financed.
Each state defines its general fund in its own way, and accounting
practices also differ substantially from state to state, so comparisons
of general fund statistics among states must be made with care. As
a general rule, the general fund does not include most revenue from
charges and fees, nor do most states include federal aid in the gen-
eral fund. Most states earmark certain taxes to go to special funds
outside the general fund for example, for highway construction and
OCR for page 286
286
Steven D. Gold
maintenance. Despite the complications arising from the diversity
of state fund structures, the general fund is the best indicator of
state fiscal activity that is, if balances in budget stabilization funds
are added to a state's general fund and if the spending, tax, and
accounting practices that influence it are taken into account (Na-
tional Governors' Association/National Association of State Budget
Officers, 1978~.
There are three important differences between state general fund
balances and NIPA surplus/deficit estimates:
1. As explained earlier, the general fund is much less inclusive,
excluding many autonomous state bodies, most if not all user charges,
federal aid, and earmarked revenue.
2. Unlike NTPA estimates, state surveys of general fund balances
make it possible to disaggregate national trends and to determine if
a few large states are having a major impact on aggregate totals.
3. The balance in the state general fund is a stock of money, not
a flow, and it includes any surpluses or deficits carried over from the
previous fiscal period.
A recent study by the National Conference of State Legislatures
concluded that the general fund balance is a better indicator of state
fiscal conditions than the NIPA surplus figure (Gold, 1986b). One
important advantage is the disaggregation by state, which shows
whether a small number of states may be distorting the national
situation. A second advantage of using the general fund balance is
that it avoids NIPA's treatment of capital finance; the NIPA measure
distorts the state fiscal position by giving a bias toward deficit when
debt-financed capital projects are expanding and a bias toward sur-
plus when the financing for such projects is being retired. Third, the
general fund is a better measure of available funds than NIPA, which
includes statutorily and constitutionally earmarked funds. Indeed,
NIPA's alI-inclusiveness is a disadvantage in periods such as the late
1970s and early 1980s, when oil prices rose sharply. During these
periods, huge increases occurred in the permanent funds of a small
number of energy states. These increases added significantly to the
surpluses in these states, but they created a false picture of robust
fiscal health because the revenue in such funds generally cannot be
tapped without a constitutional change.
An important issue in assessing the value of the. general fund
surplus as an indicator of fiscal health is the extent to which states
transfer money between it and other funds. If such transfers are
OCR for page 287
STATE FISCAL CONDITIONS
287
large and are frequently made whenever the general fund is short of
funds, it would be seriously misleading to ignore accounts outside the
general fund. This is not the case, however. Some outside accounts
were tapped during the period of state fiscal stress in 1982-1983, but
such transfers are usually not significant from a national perspective.
Overall, general fund balances fluctuate much more than balances
in most other accounts. Although state special funds may have
larger total balances than the general fund, they do not have to be
considered if the balances are relatively stable (Gold, 1986b).
An important qualification to this statement, however, concerns
budget stabilization or "rainy day" funds. More than half of the
states have established such funds, most within the past 5 years.
Their function is to receive revenues during periods of relative fiscal
ease so that budget adjustments during fiscal crises will not have
to be as large. Because these stabilization funds are expected to
augment the general fund when revenue receipts lag, the division of
balances between a state's general fund and its rainy day fund is
largely arbitrary, and it is appropriate to consider rainy day funds
along with general fund balances in assessing state resources.
Projections of general fund balances have often proved inac-
curate: they tend to be too optimistic when the economy is in a
recession and too pessimistic when economic trends are positive. A
small error in forecasting revenues can lead to a large error in the
projected year-end balance. Suppose, for example, that a state has
projected a 4 percent year-end balance and $10 billion in revenues for
the year. If revenues were just 5 percent below the level forecasted,
which is not a particularly large forecasting error, the state would
have a 1 percent budget deficit, which would probably be dealt with
by reducing expenditures below the level originally appropriated. To
avoid such a problem, it is prudent for states to maintain relatively
large balances. A widely used benchmark is that the year-end bal-
ance of both the general fund and the rainy day fund should be at
least 5 percent of general fund expenditures. This standard is cited
frequently by Wall Street analysts who evaluate the creditworthi-
ness of states. Some states traditionally have maintained smaller
balances, but this method usually requires accounting practices that
enable them to tap other resources when revenue shortfalls occur.
A third indicator of a state's fiscal condition is the financial
assets held by the state, as reported by the Bureau of the Census in
its series of annual reports on state governments. This measure is
available for individual states, but for any particular state it suffers
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288
Seeders D. Gold
from the same problem as NIPA data a high degree of aggregation.
All state assets that are not in social insurance or bond funds are
added together; consequently, a large proportion of this total may be
the assets held by independent or quasi-independent organizations
such as housing finance agencies and universities (Gold, 1986b).
Although many past analyses have concentrated on a single
figure the NIPA surplus or the general fund balance as a proportion
of expenditures as an indicator of fiscal conditions, this approach is
incomplete. It is necessary to consider as well the spending, tax, and
accounting practices that were in effect in a state. If a state has a
relatively large surplus only because it reduced spending and raised
taxes, for example, that is quite a different matter from a surplus
that occurs in the face of higher spending and reduced taxes.
Most states adopt fiscal and accounting practices that understate
the true degree of fluctuation in balances. In order to avoid a deficit,
which is not permitted in most states by constitutional provision or
statute, states may defer certain expenditures (e.g., aid to school
districts) and accelerate revenues. This action was taken by many
states during the 1982-1983 period of severe fiscal stress. Some of
these actions were then reversed when fiscal conditions improved.
Although changes in accounting practices affect how fiscal conditions
appear from year to year, they have not biased trends systematically
over time and consequently are not discussed in the next section of
this report.
STATE FISCAL CONDITIONS IN RECENT YEARS
State fiscal conditions have been volatile over the last 10 years-
very good in the late 1970s, very poor in the early 1980s, then
improved in the mid-1980s but not as good as they were in the
1970s. Economic trends and changing tax policies are of primary im-
portance in explaining these trends. Spending policies have followed
rather than led the deterioration and improvements in fiscal condi-
tions. Cutbacks in federal aid have been a negative factor affecting
the fiscal condition of the states.
Table 1 shows total general fund balances annually from fiscal
years 1978-1985, as reported by the the National Governors' Associa-
tion/National Association of State Budget Officers (NGA/NASBO).
The balances peaked in fiscal year 1980 at $11.8 billion, representing
9 percent of expenditures. They then declined steadily until 1983,
when they were only $2 billion or 1.3 percent of spending. In the next
OCR for page 289
STATE FISCAL CONDITIONS
TABLE 1 States' General Fund Year-End Balances
(in billions of dollars), Fiscal Years 1978-1985
Year-End Percentage of
Year Balance Expenditures
1985 8.0 4.3
1984 5.6 3.3
1983 2.0 1.3
1982 4.5 2.9
1981 6.5 4.4
1980 .11.8 9.0
1979 11.2 8.7
1978 8.9 8.6
NOTE: Fiscal years in 46 states conclude on June 30.
SOURCE: National Governors' Association/National
Association of State Budget Officers (1986:173.
289
2 fiscal years, general fund balances rebounded, reaching $8 billion
in 1985.
National figures on budget stabilization~funds are available only
for 1984 and 1985 when the funds stood at $0.8 billion and $1.7
billion, respectively (National Governors' Association/National As-
sociation of State Budget Officers, 19863.: Adding the stabilization
funds makes the total balances in 1984 and 1985 $6.4 billion and
$9.7 billion, respectively, or 3.8 percent and 5.3 percent of general
fund expenditures. The improvement in state fiscal conditions that
had been occurring since their Tow point in 1983 ended in fiscal year
1986. According to NGA/NASBO's survey, states ended that year
with balances of $6.5 billion, of which $1.5 billion was in stabilization
funds. This figure represented about 3.2 percent of expenditures.
NIPA figures show a similar pattern during the 1980s, as Table
2 indicates. (Note that these figures are for calendar rather than
iThe National Governors' Association/National Association of State Bud-
get Officers reports smaller stabilization funds than the National Conference of
State Legislatures because it does not include the balances in some states in
which the entire year-end balance is included as part of the stabilization fund.
This difference of treatment affects the division between the general fund and
stabilization fund but not the total reported balance (Gold et al., 1985~. In
earlier years, balances in stabilization funds were considerably lower, especially
at the end of 1983.
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290
Stever' D. Gold
TABLE 2 State and Local Surplus or Deficit (in
billions of dollars) in National Income and Product
Accounts, Calendar Years 1970-1984
Calendar Year
Local
States Governments
1984
1983
1982
1981
1980
1979
1978
1977
1976
1975
1974
1973
1972
1971
1970
11.5
-0.9
-7.4
1.2
0.0
1.6
4.5
3.0
-1.4
-5.8
-3.9
0.6
3.4
-4.3
-4.4
6.4
5.7
3.0
-0.2
2.2
4.1
6.0
1.0
-2.9
0.2
3.2
1.4
-0.8
-0.7
SOURCE: Levin and Peters (1986).
fiscal years.) After a $4.5 billion surplus in 1978, states' finances
deteriorated significantly, plunging to a $7.4 billion deficit in 1982.
A small deficit also occurred the next year, but the surplus soared
to $11.5 billion in 1984. Separate surplus figures for state and local
governments are not available yet for 1985, but the combined surplus
fell from $15.9 billion to $6.1 billion, with the states presumably
being responsible for most of this decrease (Levin and Peters, 1986~.
Table 2 also shows the local surplus for comparison purposes. It has
not been as unstable as the state surplus, nor was it as low in the
1981-1983 period.
A major value of general fund data is that they are available
for all states, thus permitting comparisons of state fiscal conditions.
Table 3 shows balances (including rainy day funds) for fiscal years
1985, 1986, and 1987 (projected). The differences among the states
were even greater in 1983, when 8 states ended the fiscal year with
deficits and 15 others had balances equal to 1 percent or less of
spending while 9 states had balances equal to 5 percent or more of
spending (Gold and Benker, 1983~. One of the ironies of the present
situation is the reversal of fortunes that has taken place in state fiscal
conditions. Currently, the most fiscally stressed states are those rich
OCR for page 291
STATE FISCAL CONDITIONS
291
in natural resources and the farm states, which were among the
leaststressed when oil and grain prices were high in the 1970s; some
of the northeastern states that were depressed in the mid-1970s are
now relatively well off.
Three major factors account for these fluctuations in fiscal con-
ditions: (1) the economy, (2) changes in state tax policy, and (3)
cutbacks in federal aid.
Econonuc mends
The American economy, which is the most important determi-
nant of state fiscal conditions, underwent two recessions in the early
1980s in 1980 and 1981-1982. The first recession was intense but
brief, and the second was the most severe in 40 years. Their impact
is clearly visible in Tables 1 and 2: they caused massive revenue
shortfalls that plunged many states close to deficit situations. The
impact of the recessions on the states was particularly severe because
many had based their fiscal year 1983 budgets on predictions that
the recession would end by the summer of 1982 (Gold, 1983~. The
economic recovery that began in December 1982 did not become
apparent to state budgeters until mid-1983 because of the lags that
exist between economic developments and state tax collections. The
nation's improved economy was one of the two main reasons for the
enhanced fiscal condition of the states in the mid-1980s.
Tax Policies
Tax policy was another important influence on state fiscal con-
ditions. Although California's Proposition 13 dealt with local rather
than state taxes, the tax revolt it dramatized encouraged many
states to cut their state taxes. Thirty-two states reduced their per-
sonal income or general sales taxes in 1978, 1979, or 1980. Some of
these reductions were temporary, but many were permanent. They
resulted in an immediate reduction in tax collections, which kept bal-
ances below the level they would have otherwise achieved and also
in many cases reduced the productivity of the tax system in future
years (Gold, 1983~.
The tax revolt not only resulted in tax reductions; it also inhib-
ited the enactment of tax rate increases for a number of years. Only
two states raised income or sales taxes in the 1978-1980 period, and
there were no personal income tax increases and only five sales tax
OCR for page 292
292
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OCR for page 294
294
Steven D. Gold
increases in 1981. This legacy of the tax revolt began to weaken in
1982, however. In John Shannon's colorful terminology, tax increases
in the post-Proposition 13 environment were acts of fiscal desperation
that occurred only when there was already "blood on the floor."
Nine states raised their income or sales taxes in 1982, five of them
in the last 2 months of the year. Looking back, this pattern was
a precursor of the greatest explosion of state tax increases ever: in
1983, tax increases enacted by the states totaled $8.25 billion. (In a
few earlier years particularly 1967, 1969, and 1971—tax increases
were a larger percentage of total state tax revenue, but in absolute
terms tax increases were never as great.) Thirty-eight states raised
at least 1 tax, and there were 16 personal income tax and 11 general
sales tax raises. There were no significant tax cuts. These tax
increases contributed substantially to the improvement in state fiscal
conditions in fiscal years 1984 and 1985 (Gold, 1984~.
By 1984, however, the tax increases were beginning to be re-
versed. Many of them had originally been temporary, and contrary
to the cynical attitude that temporary taxes are seldom lifted, most
of them did expire, especially the increases in personal income taxes.
In addition, as general fund balances grew, many states rolled back
"permanent" increases enacted in 1982 and 1983. The great major-
ity of sales tax increases remained in effect, but three-quarters of the
states that increased their personal income taxes in 1982 and 1983
either eliminated or partially rolled back those increases by the end
of 1985. These reductions contributed to the decrease in the NIPA
surplus in 1985 and the drop in general fund balances in fiscal year
1986. Although numerous, most of these tax cuts were moderate in
size. As a result, the net first-year reduction in tax revenue resulting
from tax cuts legislated in 1985 was considerably less than 1 percent
of total state tax revenue. When fully phased in, the tax cuts will
represent less than 2 percent of total tax revenue (Gold, 1986a).
Tables 4 en cl 5 summarize recent tax policy and provide some
long-term perspective. Table 4 shows the magnitude of state tax
increases and decreases legislated each year since 1963. The decrease
in 1985 was only the third] over this 23-year period. One reason
for the preponderance of net increases is that at least a few states
every year raise their excise taxes on such products as gasoline and
cigarettes.
Yet these statistics about legislative actions tell only part of the
story. Most of the increase in state tax revenue occurs as the result
of economic growth and inflation, which together tend to push up
OCR for page 297
STATE FISCAL CONDITIONS
297
the states that boosted their sales taxes to support education in this
decade.
What do these statistics (along with the history they encapsu-
late) suggest about the ability of state governments to raise taxes
from their present level? As a proportion of personal income, state
taxes are about 5 percent below their peak level of 1978. Recent
experience suggests that it is politically feasible to boost taxes when
a strong case can be made for the necessity of such action—because
of either financial difficulties (provided that a period of "belt tight-
ening" has occurred before the tax increase) or the need to improve
elementary and secondary schools. If a strong political case is estab-
lished, taxes can be raised. In most states there is room to increase
taxes without raising them to a higher proportion of personal income
than they were previously. On the other hand, recent history also
suggests that it is not easy to raise taxes for one reason (for example,
a short-term fiscal problem) and then to maintain the new rate once
the original reason is no longer valid (as may have often occurred in
the past). As discussed in the final section of this report, the legacy
of the tax revolt and interstate tax competition both constrain the
ability of states to raise taxes.
The situation appears different if local taxes are also considered.
Local taxes are more than 20 percent below their highest level (in
1972) as a proportion of personal income. Combined state and local
taxes are about 11 percent below their 1973 peak. Of course, it would
not be easy to boost local taxes significantly, but that is one possible
avenue for expanding state and local resources.
This discussion has focused on tax revenue because taxes are the
most visible and important source of revenue. Part of the reason
taxes have risen so little, particularly at the local level, is the in-
creased reliance of governments on nontax revenue. In 1984, charges
and miscellaneous revenue per $100 of personal income were $4.59
per $100 of personal income for state and local governments, a major
increase from $3.19 in 1973 (the peak year for taxes). Total own-
source state and local revenue in 1984 was slightly above its previous
peak of 1978; tax revenue, on the other hand, wan 10 percent lower.
The increase in nontax revenue has been much greater for miscelIa-
neous revenue (e.g., interest received) than for charges, and it has
been considerably larger at the local than at the state level.2 An
2 Between 1978-1984, local general revenues rose 65.9 percent, with major
components rising as follows: federal aid, 7.8 percent; state aid, 64 percent;
taxes, 53.5 percent; charges, 104.7 percent; and miscellaneous revenue, 224.1
OCR for page 298
298
Steuer~ D. Gold
important part of this rise in nontax revenue, which did not sup-
port core services, was for nontraditional activities such as mortgage
subsidy programs.
Federal Aid
The third outside influence on state fiscal conditions, in addi-
tion to the economy and the tax revolt, has been federal aid policy.
Federal aid is commonly divided into two parts: grants for payments
to individuals (e.g., as Aid to Families with Dependent Children
tAFDC]) and all other grants. The first category has grown con-
siderably over time, relative to the second category. In fiscal year
1986, for example, grants for payments to individuals were 46 per-
cent of total fecleral aid, a significant increase from their 35 percent
share in fiscal year 1980. This shifting composition of federal aid
implies that aid to state and local governments that is not simply
passed through to individuals has decreased much more than total
aid has decreased. According to one estimate, federal aid to state
and local governments, excluding grants for payments to individuals,
was stashed 23.5 percent between 1980 and 1985 (Rymarowicz and
Zimmerman, 1986~. Federal aid cutbacks have affected local govern-
ments more than states, although the difference is hard to measure
precisely. According to NIPA, between 1980 and 1984 federal aid
to states rose 15 percent in nominal dollars whereas federal aid to
local governments dropped 20 percent. These figures are somewhat
misreading, however, because grants for payments to individuals are
received primarily by states.
Census Bureau statistics, summarized in Table 6, provide ad-
ditional detail about the changing shape of federal aid to states.
Federal aid for public welfare jumped from 39.9 percent of the total
in fiscal year 1980 to 46.5 percent in 1984. The major reason for this
increase was rapidly increasing Medicaid costs, which are included
in the welfare category. Aid for health and hospital programs also
rose at an above-average rate, but aid for education and highways
trailed behind. Federal aid outside of these four major categories de-
creased slightly, primarily because general revenue sharing for states
was eliminated during this periocI. (Note that these statistics are for
percent. For states, the corresponding percentages were: total, 74.9 percent;
federal aid, 51.7 percent; taxes, 73.8 percent; charges, 89;9 percent; and
miscellaneous revenue, 203.3 percent (Bureau of the Census, 1980, 1985a).
OCR for page 299
STATE FISCAL CONDITIONS
TABLE 6 Federal Aid to States, Fiscal Years 1980 and 1984
Percentage of Total Grants Percentage Change'
Category 1980 1984 1980-1984
Public welfare 39.9 46.5 43.5
Education 20.6 18.4 9.5
Highways 14.3 13.6 17.2
Health and hospitals 3.7 4.3 40.5
All other 21.5 17.2 -1.4
Total 100.0 100.0 23.0
SOURCE: Bureau of the Census (19131, 1985b).
299
state fiscal years; because the NIPA data in the previous paragraph
are for calendar years, the total change in aid differs between the two
sources.)
State expenditure policy has been relatively restrained. For the
6-year period 1979-1984, there were only 2 years when real genera]
fund spending increased by more than 1.5 percent (Table 7~. In 3
years there were decreases in real expenditures. Much spending was
deferred during those years, and a significant amount of "catch up"
spending occurred as state fiscal conditions improved. General fund
spending jumped sharply in fiscal years 1985 and 1986 for this reason.
STATE AID TO FOCAL GOVE:RNM1:NTS
Aid to local governments is the largest component of state bud-
gets. The Bureau of the Census reports that, in fiscal year 1984,
states provided $106.7 billion of aid to focal governments, accounting
for more than one-third of total state general spending (see Table
10~. This statistic, however, is misleading. On the one hand, it
counts federal aid that merely passes through states on its way to
local governments (e.g., financing for AFDC in states in which such
aid is partially a local function). On the other hand, it gives no credit
for some very significant increases in assistance provided by states to
local governments over the past quarter-century.
The most important distortion arises from the fact that when a
state assumes complete responsibility for a particular program, that
program ceases to be a local responsibility; hence, the money spent
by the state does not count as local aid. Consider, for example, two
states: one of the states fully funds its $1 billion Medicaid program;
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300
Steven D. Gold
the other finances three-quarters of Medicaid and requires counties
to finance the other 25 percent. The first state is credited with no
local aid for Medicaid; the second state will normally be considered
to provide $750 million of aid in this area. This phenomenon is
most important for Medicaid and AFDC, two programs with large
expenditures for which many states have assumed complete financial
responsibility since the 1960s. As states assume these programs, total
state aid to local governments is reduced in Census Bureau statistics.
The composition of aid by function is shown in Table 8. Educa-
tion is by far the most important function supported by state aid,
accounting for more than $5 out of every $8 of aid in 1984. This
proportion has been relatively stable over the past quarter century,
although state aid for elementary and secondary schools jumped 30
percent between 1983 and 1986. The increase in state aid was rel-
atively larger than the increases in local funding and federal aid,
and state aid accounted for 50.1 percent of the costs of elementary
and secondary schools in 1986, compared with 47.9 percent in 1983
(National Education Association, 1986~.
Public welfare spending (including Medicaid) has decreased con-
siderably from 18.9 percent of the total in 1972 to 11.2 percent in
1984. Part of this decrease is due to the creation of the federal
TABLE 7 General Fund Spending Increases
(percentages), Nominal and Real, Fiscal Years
1979-1986
Year
Nominal Real
Increase Increasea
1986
1985
1984
1983
1982
1981
1980
1979
9.5
10.2
8.0
-0.7
6.4
16.3
10.1
10.1
4.3
4.6
3.3
-6.3
-1.1
6.1
-0.5
1.5
aReal increases were estimated using the implicit
deflator for state and local governments.
SOURCE: National Governors' Association/National
Association of State Budget Officers (1986:4~.
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STATE FISCAL CONDITIONS
TABLE 8 State Aid to Local Governments (percentage of total) by Function for
Selected Fiscal Years
301
Function 1984 1980 1977 1972 1967 1962 1957
Education 63.3 63.7 60.5 57.7 62.2 59.4 56.6
Public welfare 11.2 11.2 14.3 18.9 15.2 16.3 15.3
General local
govt. support 10.1 10.4 10.4 10.2 8.3 7.7 9.0
Highway ye 5.3 5.3 5.9 7.2 9.8 12.2 14.6
Othem 10.1 9.4 8.9 6.1 4.5 4.4 4.6
Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0
The largest categories of "other" aid are for health, transit, corrections, housing and
community development, and sewerage.
SOURCE: Bureau of the Census tl959, 1968, 1979, 1981, 1985b); Advisory Commission on
Intergovernmental Relations (1977:10, 16-17).
Supplemental Security Income program in 1974, which relieved both
state and local governments of their welfare costs for the aged, blind,
and disabled, but states' assumption of financing for local welfare
programs also contributed. General local government support has
been steady over the period 1972-1984, with slightly more than a
tenth of local aid. Support for highways, however, has decreased
sharply as a proportion, mirroring the decline in highway spending
as a proportion of total state and local spending. The increase in
miscellaneous aid, with its share more than doubling between 1967
and 1984, reflects the fact that states have become involved in some
nontraditional areas. Aid for transit programs is a good example of
an emerging focus of state aid. States gave local governments $1.5
billion of aid for transit in 1984, an increase of 143 percent since 1979
and 28 percent since 1982.
In view of the functional distribution of aid just described, it is
not surprising that school districts and counties receive much more
state aid than municipalities. In 1984 their shares of total state aid
were 52.4 percent and 22.4 percent, respectively, as shown in Table 9.
School districts, of course, provide most of the educational services,
although cities and counties are important in the education function
in a number of states. Counties traditionally are the major providers
of welfare services. Municipalities receive only 16.3 percent of state
aid.
Table 10 shows how aid to local governments has grown over
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302
Steven D. Gold
TABLE 9 State Aid to Local Governments (percentage of total) by
Recipient Government, Selected Fiscal Years
Recipient 1984 1980 1977 1967 1957
School districts 52.4 51.8 47.6 50.2 48.1
Counties 22.4 22.2 22.6 24.9 27.6
Municipalities 16.3 15.2 19.3 21.3 20.2
Townships" 1.1 1.3 1.2 3.1 3.7
Special Districts 1.2 1.2 1.1 0.5 0.3
Combined and unallocable 6.6 8.5 8.2 0.0 0.0
aIncludes New England "towns."
SOURCE: Bureau of the Census (1959, 1968, 1979, 1981, 1985b); Advisory
Commission on Intergovernmental Relations (1977:10, 16-17~.
TABLE 10 State Aid to Local Governments, Per Capita and as Proportion of Total
State Spending, Selected Fiscal Years
State-Local Aid 1984 1980 1977 1972 1967 1962 1957
Total (billions of dollars) 106.65 82.76 61.07 36.76 19.06 10.91 7.44
Per capita (dollars) 452.75 365.54 278.70 176.07 96.43 58.92 43.64
Per capita (1972 dollars) 185.44 200.19 194.42 176.07 137.17 99.81 84.90
As percentage of total
state spending 34.4 36.3 36.8 37.2 35.7 34.9 35.3
SOURCE: Bureau of the Census (1979:9-10, 1981:52, 1985b).
time. It was nearly 10 times as great in 1984 as it had been in 1962.
Although the absolute amount of aid has grown impressively and
continues to increase in per capita terms, per capita sect failed to
keep up with inflation between 1980-1984, dropping about 6 percent
over that 4-year period. Aid has also been remarkably constant as
a proportion of tote] state spending, fluctuating between 34 percent
and 37 percent since 1957.
OUTLOOK FOR STATE FISCAL CONDITIONS
The outlook for state finances over the next decade depends
on the course of the economy, exogenous influences on tax policy
(tax revolt sentiment and interstate tax competition), and trends in
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STATE FISCAL CONDITIONS
303
federal aid. Taking all of these factors into account, the prospects
are not particularly rosy.3
The course of the economy certainly is the most important single
factor affecting the outlook for state finances both in the aggregate
and for particular states. Currently, the farm and energy-producing
states are the most economically depressed, and their fiscal conditions
are also among the worst. As for the national economy, growth has
not been particularly strong in this decade. In view of the problems
arising from the federal budget and international trade deficits and
Third World clebt, the potential for serious dislocations appears
significant.
The legacy of the tax revolt continues to restrict potential state
revenues. As one review of the experience in California concluded,
the tax revolt "is dormant, not dead" (Citrin and Green, 1985~. Two
Michigan senators were recalled in 1983 after they had voted for
an income tax increase, and initiatives to repeal tax increases were
defeated in Ohio in 1983 and Michigan in 1984 only after hard-fought
campaigns. The widespread elimination in 1984 and 1985 of income
tax (and some sales tax) increases that had been passed in 1982 and
1983 reflected the feeling of public officials that citizens did not wart
tax rates increased permanently.
The tax revolt also lives on in legislation and some state consti-
tutions. Fourteen of the 40 states with personal income taxes have in-
dexed them, at least partially. These provisions permanently reduce
the built-in growth rate of this major source of revenue. Seventeen
states have spending or revenue limits that place a lid on the growth
3 this prognosis is somewhat at variance with the conclusions of a 1985
Treasury Department study based on a simple model of the state and local
sector. That study argued that if state and local governments maintained
their current tax systems and service levels and if the Reagan administration's
federal aid projections and economic forecasts were accurate, large surpluses
would develop in aggregate state and local budgets. State and local governments
would not allow this to occur, however, and would therefore reduce tax levels,
increase services, or enact some combination of these options (U.S. Department
of the Treasury, 1985~.
The Treasury study also showed that if economic performance is much
poorer than predicted by the administration and most leading forecasters, the
fiscal situation of state and local governments would be much worse. The study
is also open to question on several technical grounds, such as its assumptions
about the responsiveness of state and local tax revenue to economic growth (an
issue on which most estimates are outdated) and the expenditures necessary to
maintain current service levels.
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304
Steverz D. Gold
of state fiscal activity, usually tying it to the rate of increase of per-
sonal income or to the sum of the inflation and population growth
rates (Gold, 1984~. Enacted between 1977 and 1982, nearly all of
these limits have not been restrictive in their initial years because
growth in tax revenue was relatively sluggish, in part because of tax
cuts. The limits are likely to become more significant in the future,
however. Michigan and California are very close to their limits, and
some officials have concluded that they have exceeded them. Virtu-
ally none of these limitation measures has provisions that will allow
some liberalizing of them if the state has to assume responsibilities
cast off by the federal government.
Several other factors add to the problems facing state tax sys-
tems. Although difficult to measure, interstate tax competition ap-
pears to have intensified, manifesting itself in the proliferation of
business tax incentives and in pressure for states with high personal
income tax rates to lower them. Because virtually all states engage in
this competition, each state's actions tend to be canceled out by the
behavior of other states; the result is merely reduced state and local
tax revenue, with little if any economic advantage for the states.
Reductions of maximum income tax rates also reduce the buiTt-in
responsiveness of tax revenue to economic growth. In addition, tax
bases are being eroded by economic trends: retirement income is
often partially exempt from the income tax, and it is growing much
faster than taxable income. Likewise, most services are exempt from
the sales tax, and they are claiming a growing share of consumer
expenditures. These developments dampen the growth of state tax
revenue.
Federal tax reform is likely to exacerbate interstate tax competi-
tion because lower federal marginal tax rates imply that differentials
in state and local tax rates will be more significant. Currently, ~high"
federal tax rates "shield" state and local governments to some extent
with above-average tax rates because each dollar paid to a state or
locality substantially reduces federal tax liability. After federal tax
reform, however, the Federal offset" will be considerably smaller.
Other ejects of federal tax reform tend to offset each other. States
with an income tax will benefit from a broader tax base to the extent
that they conform to the federal definition of taxable income, but
lower marginal rates will increase the cost of borrowing for state
and local governments and perhaps result in a decrease in charitable
contributions, which could increase the demand for state and Tocad
services that substitute for charitable activity.
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STATE FISCAL CONDITIONS
305
Reductions in federal aid are a final negative factor for state
finances. In view of the pressure to reduce the federal budget deficit,
the major question appears to be the rate at which real federal aid
decreases not whether it will continue to fall. Excluding grants
for payments to individuals, the Reagan administration projects a
real decrease of 37 percent in aid to state and local governments
between 1985 and 1991 (Office of Management and Budget, 19863.
Future fevers aid cuts will probably have greater fiscal effects on the
states than past cuts have had because states will be under much
greater pressure to replace lost federal revenue, given the nature
of the programs affected. Reductions in such areas as transit and
wastewater treatment will generally be too significant for states to
ignore.
As a result of these forces economic trends, constraints on tax
policy, and federal aid cuts many states will probably experience
some degree of fiscal stress in the next decade. Such stress implies
that it will not be easy for states to increase their urban aid by a large
amount, a statement that seems particularly valid because urban aid
will face stiff competition from other claimants on state budgets,
especially school, infrastructure, and social service programs. (Of
course, to some extent, each of these "rivals has an important
urban aspect itself.)
One of the most potent political forces in most state capitals
is the education lobby- and appropriately so because education is
widely viewed as the most important service funded by states and
localities. The education lobby has become even more powerful
since 1983 because of the educational reform movement that has
sprung from dissatisfaction with the products of the nation's schools.
Improving the educational system could be very expensive. For
example, to implement fully the recent proposals of the Task Force
on Teaching as a Profession for the Carnegie Forum on Education
and the Economy would cost about $48 billion per year. Even if
educational reform claims only a fraction of this amount, it would
draw scarce state dollars from possible urban initiatives.
If fiscal stress develops as the preceding paragraphs suggest it
may, how will state governments respond? One part of their response
should be a thorough reexamination of existing programs to improve
their efficiency and eliminate those of low priority; states should also
consider new funding mechanisms (which in practice will often result
in increased privatization). Furthermore, relations between state and
local governments wit! probably change in important ways. States
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306
Steven D. Gold
will recognize the need to reassess their existing policies toward
local governments, and many restrictions currently in force will be
relaxed, including restrictions on available taxes and some mandates.
States will certainly replace some of the federal aid lost by local
governments, but the mechanisms they use may not follow precisely
the format used in federal programs. Much lost federal aid also will
not be replaced by states.
The same forces causing fiscal stress at the state level during
the next decade will tend to produce even greater stress for many
urban governments. States will not be blind to this development,
but their ability to respond with increased aid will be constrained by
the restrictions on their fiscal capacity discussed in this report.
REFERENCES
Advisory Commission on Intergovernmental Relations
1977 The States a?~dIntergovernmentalAids. Report A-59. Washington, D.C.:
Advisory Commission on Intergovernmental Relations.
Bureau of the Census
1959 Censor of Govermerds: 1957. Vol. 4, No. 2. State Payments to Local
Goverr~mer~ts. Washington, D.C.: U.S. Department of Commerce.
1968 Census of Goverment~: 1967. Vol. 6, No. 4. State Payments to Local
Government. Washington, D.C.: U.S. Department of Commerce.
1979 (renew of Goverments: 1977. Vol. 6, No. 3. State Payments to Local
Governments. Washington, D.C.: U.S. Department of Commerce.
1980 Governmental Finances in 19~77-78. Series GF80, No. 5. Washington,
D.C.: U.S. Department of Commerce.
1981 State Government Finances in 1980. Series GF80, No. 3. Washington,
D.C.: U.S. Department of Commerce.
1985a Government Finances in 1985-84. Series GF80, No. 5. Washington,
D.C.: U.S. Department of Commerce.
1985b State Government Finances in 1984. Series GF80, No. 3. Washington,
D.C.: U.S. Department of Commerce.
Citrin, J., and D. P. Green
1985 Policy and opinion in California after Proposition 13. National Tax
Journal 38:15-35.
Gold, Steven D.
1983 Recent developments in state finances. National Tan Journal 36:1-29.
1984 State tax increases of 1983: Prelude to another tax revolt? National
Tan Journal 37:9-22.
1986a Developments in State Finances, 1983 to 1986. Public Budgeting arid
Finance 7(Spring 1987~:5-23.
1986b State Government Fund Balances, Financial Assets, and Measures of
Budget Surplus. In Federal-State-Local Fiscal Relations: Technical
Papers. Office of State and Local Finance. Washington, D.C.: U.S.
Department of the Treasury.
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STATE FISCAL CONDITIONS
307
Gold, Steven D., and Karen M. Benker
1983 State Budget Action in 1988. Denver, Colo.: National Conference of
State Legislatures.
Gold, Steven D., Corina L. Eckl, and Max R. Price
1985 State Budget Action ire 1985. Denver, Colo.: National Conference of
State Legislatures.
Levin, David, and Donald Peters
1986 Receipts and expenditures of state and local governments: Re-
vised and updated estimates, 1959-84. Survey of Current Business
66(May) :26-29.
National Education Association
1986 Estimates of School Statistics: 1985-86. Washington, D.C.: National
Education Association.
National Governors' Association/National Association of State Budget Officers
1978 Under~tar~ g the Fiscal Condition of the States. Washington, D.C.:
National Governors' Association/National Association of State Budget
Officers.
1986 Fiscal Survey of the States: 1986. Washington, D.C.: National Governors'
Association/National Association of State Budget Officers.
Office of Management and Budget
1986 Budget of the Orbited States Government, 1987—Historical Tables. Wash-
ington, D.C.: U.S. Government Printing Office.
Rymarowicz, L., and D. Zimmerman
1986 The Effect of Federal Tan and Budget Policies ire the 1980s or' the State-Local
Sector. Washington, D.C.: Congressional Research Service.
U.S. Department of the Treasury
1985 Federal-State-Local Focal Relations: Report to the President arid the
Cor~gre~. Office of State and Local Finance. Washington, D.C.:
U.S. Department of the Treasury.
Representative terms from entire chapter:
state fiscal
