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STATE FINANCIAL TRENDS

The Pew Charitable Trusts recently released t results of its survey of rends in state spending since the Great Recession. What initially caught our eye is the data on spending on education. We can’t help but note the correlation between decreased spending on public higher education and the rise of the cost of a college education and the concern about student loan indebtedness. It helps to explain the political pressure to increase spending to support institutions directly or to do it by providing tuition free access to the public higher education system.

Despite nearly 10 years of national economic growth—in what would be the longest U.S. expansion on record by the end of June 2019—states haven’t fully erased the effects of the recession. States still have not fully restored cuts in funding for infrastructure, public schools and universities, the number of state workers, and support for local governments. Nearly a fifth of states collect less revenue than before the downturn, more than a third have smaller rainy day funds, and almost half spend less from their general fund budgets than a decade earlier. Meanwhile, fixed costs—for Medicaid and underfunded public pension systems—are higher in almost every state.

The recession undercut states’ largest source of revenue: tax dollars. States missed out on an estimated $283 billion when collections fell and remained below 2008’s level until 2013 after adjusting for inflation.  Even though total state tax collections in late 2018 were 13.4 % higher than a decade ago, based on quarterly tax revenue collections adjusted for inflation, nine states still were taking in fewer tax dollars than at their peak before receipts fell in the 2007-09 downturn.

Spending from states’ general funds—the largest source of state expenditures—has surpassed pre-recession levels by 4.3 % after adjusting for inflation. In fiscal year 2018, 23 states still spent less in inflation-adjusted terms than in fiscal 2008. Spending in nine states in fiscal 2018 was more than 10 % below fiscal 2008 levels. Nowhere was spending down more than in Alaska—by nearly a third compared with a decade ago. Still, 14 states were spending at least 10 % more than at the start of the recession, led by North Dakota’s 53 % jump since fiscal 2008.

State financial support for higher education—the third-biggest slice of state budgets—was still 13 percent below its high before the downturn on a per-student basis after adjusting for inflation. States now rely primarily on tuition revenue from students and their families, rather than state support, to fund public higher education. Nationally, tuition dollars collected by public universities jumped 43 % per student from 2008 to 2018 after adjusting for inflation.

State financial support peaked at $9,248 per full-time-equivalent student in fiscal 2008 and fell by about a quarter to its lowest level of $6,888 in fiscal 2012. State support has partially recovered but still remained 13 % below fiscal 2008 levels in 2018, at $8,073 per student. In total dollar terms, this meant states spent $88.2 billion in 2018, 7 % less than in 2008 after adjusting for inflation. Preliminary data show that total nominal state support for higher education increased in 2019 for the seventh year in a row, though support is expected to remain highly sensitive to economic slowdowns.15

Seven years after the recession ended, state funding per pupil for public elementary and secondary schools—the largest area of states’ general fund budgets—stood at $6,745 nationally, below 2008 levels by about 1.7 %, or nearly $120 per pupil, after adjusting for inflation. State support per pupil was lower in a majority of states—29—in academic year 2016 compared with 2008, according to the most recent available data, and was down at least 10 % in nine of those states. Initial data for 2017 and 2018 show that more than 20 states continued to provide less per-pupil funding than at the start of the recession.

Primary and secondary schools receive roughly 45 % of their funding from the state, with a nearly equal share from local governments. The mix varies widely, so both funding streams are important in gauging the recession’s full effect on education. After the downturn, both state and local funding fell on a per-pupil basis when faced with declining tax revenue. Although the 50-state total for this combined funding has surpassed 2008 levels, schools in 20 states still received fewer dollars per pupil from state and local funds in 2016.

Wrapped up in school funding are teacher salaries, which on average were still below pre-recession levels in 2016 in real dollars. But how much teachers earn and who funds their salaries differ significantly by state. Even an increase in per-pupil spending doesn’t necessarily mean more dollars for salaries and classrooms. For example, an increase also could reflect rising pension contributions.

In the wake of the recession, state governments reduced investing in infrastructure. As a share of the economy, state spending on fixed assets—such as highways, sidewalks, airfields, electronics, or software—has been falling since 2009.20

In real dollars, state governments’ investments in infrastructure dropped by 3.2 % from 2007 to 2017, with ups and downs along the way. But infrastructure spending relative to gross domestic product (GDP) dropped almost every year between a 2009 peak and 2017, following more than two decades of stability. In fact, 2017 marked the lowest level of funding as a share of the economy in more than half a century. States’ declining infrastructure investment relative to GDP is a sign that spending on fixed assets has not kept pace with economic growth.

Because state-level data on infrastructure investment by category are unavailable, a look into combined investments by states and localities shows that infrastructure types were affected differently. For example, transportation structures—such as air transportation and mass transit systems—seem to have been prioritized, with a nearly 30 % increase in spending. Funding for highways and streets, which generally receive the most state and local infrastructure investment, dropped 6 % between 2007 and 2017, while spending on the second-largest recipient—educational structures such as schools—fell 14 % after accounting for inflation.

In the recession’s wake, many local governments had to manage with less money from their states. Total state aid to localities was down by 5.3 % at its post-recession low point in fiscal 2013 and was still slightly lower—by just 0.8 %—at the end of fiscal 2016 than before the recession after adjusting for inflation. But local governments in 26 states received less state aid in fiscal 2016 than in fiscal 2008, the last year before tumbling tax revenue led to budget cuts and forced states to cut spending. The decline in state aid to local governments ranged from less than 0.5 % in Pennsylvania to 22.8 % in Arizona compared with fiscal 2008. 

Cutbacks in state aid put a strain on local budgets and exposed cities and other localities to greater risk of financial problems. For local governments together, state aid is the second-largest source of revenue after tax dollars, and significant cuts can lead to difficult decisions about raising other revenue or cutting spending.

One way for states to cut spending during downturns is to reduce their payroll. Whether through early retirements, buyouts, or layoffs, state agencies can cut spending by shrinking their workforce. The 2007-09 recession was no different. Total state employment, excluding teachers and other public school staff, peaked at slightly above 2.8 million public employees in 2008 as states had not yet borne the brunt of the recession. After shedding almost 170,000 jobs and reaching its lowest point in 2013, the state workforce nationwide started to grow slightly. However, in 2018, more than a decade after the recession began, state governments across the U.S. still had fewer employees, having lost 4.7 %, or more than 132,000 jobs, from the peak.

With fewer workers on government payrolls, lawmakers’ options for reducing spending in a future recession are reduced. In addition to pent-up demand to restore spending cuts from the recession, states face the challenge of rebuilding rainy day funds to prepare for the next economic downturn.

At the end of fiscal 2018, these funds held more money than in any year on record. But at least 19 states still had smaller rainy day funds as a share of general fund operating costs than in fiscal 2007—the last full budget year before the recession hit. For many states, though, even pre-recession levels were inadequate to plug huge budget gaps caused by the last recession.

Seven states had less than a week’s worth of operating costs in rainy day funds in fiscal 2018, including Wisconsin (6.8 days), Kentucky (3.0 days), Illinois (0.1 day), and Pennsylvania (less than 0.1 day). Three had nothing: Kansas, Montana, and New Jersey. Although there is no one-size-fits-all rule for how much states should save, the clock is ticking on their chances to use the economic expansion to rebuild reserves.

Medicaid costs borne by the states surged following the recession after the phaseout of a one-time infusion of federal economic recovery dollars. The extra federal aid helped states deal with a spike in enrollment in the health insurance program for low-income Americans after people lost jobs and income during the downturn. Even after the economy improved, Medicaid continued to consume a greater share of state revenue than before the recession.

Nationwide, Medicaid expenses accounted for 17.1 cents of every state-generated dollar in 2016, compared with 14.3 cents in 2007, just before the recession. Although the federal government covers at least half of the total costs of insuring Medicaid recipients, the portion shouldered by states is their second-biggest expense after K-12 education. Higher Medicaid costs can limit what states have left to fund other priorities, such as schools, transportation, and public safety.

Preliminary figures indicate that the dollars states spent on Medicaid also increased in 2017 and 2018, even though a leading cost driver—enrollment growth—began to slow. Some of the increase was due to states for the first time picking up a small share of the costs of insuring newly eligible low-income adults under the Affordable Care Act’s optional expansion of Medicaid coverage. Through 2016, the federal government covered 100 % of the costs of the expansion population. States began picking up 5 % of the costs for this population in 2017 and will gradually increase their share to 10 % by 2020.

The recession didn’t cause states’ pension funding problems, but it did compound them—first, by reducing investment returns on the assets that states had saved to fund their employees’ retirements, and second by squeezing state budgets and making it even more difficult to fully fund their annual pension payments. As a result, the gap grew between how much states had saved and how much they needed to cover the pension benefits promised to public workers. The greater the gap, the more a state would need to set aside annually simply to keep its pension debt from growing.

As of fiscal 2016, states had enough set aside to cover just 66 % of their total pension liabilities, the lowest level since fiscal 2003 (the earliest available data). The shortfall between pension assets and liabilities amounted to a collective debt of $1.35 trillion by fiscal 2016, taking into account new accounting standards that raised the 50-state total by roughly $100 billion.

Greater than expected investment returns on the back of a booming stock market in fiscal years 2017 and 2018 helped shrink the 50-state total unfunded pension liability, though estimates show that it remained near historic highs. However, market losses in the first half of fiscal 2019 threatened to reverse the progress states may have made in whittling down their pension debt.

So no, it’s not your imagination. The recovery of state fiscal positions during the 10 year recovery from the Great Recession has been slow and sporadic. The data shows that states are significantly under investing in forms of capital. The lowest infrastructure spending in half a century and significant declines in higher education spending represent serious disinvestment in those forms of capital most likely to generate the highest returns going forward in a more technologically and knowledge based economy. And it leaves many states badly positioned for the next recession.

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