State House Shell Games

For years, trickery and quick fixes have just fed the spending habit. Today the budget holes are cavernous.

Over the past two years, states have faced accumulated budget deficits of some $300 billion. Federal stimulus money helped cover about two-thirds of that gap, but state governments have had to close the rest themselves. To do so, many have resorted to tricks and gimmicks that Thomas DiNapoli, New York State—s comptroller, speaking about his own state—s budget, described as a “fiscal shell game.” Such shenanigans mortgage the future for quick fixes in the present, and are a bigger part of states— fiscal woes than most taxpayers know.

One common maneuver has been to fill budget holes with borrowed money. Arizona is Exhibit A. Since the housing bubble burst in 2007 and the state—s economy began to contract, Arizona has borrowed approximately $2 billion, relying on new debt to close 17% of its budget deficits, according to a report in the Arizona Capitol Times newspaper on Oct. 8. Among the loans: $450 million that the state plans to pay back with future revenues from its lottery. The cost to the state over the next two decades will be about $680 million in principal and interest.

Arizona has also sold its state government buildings, including those that house its Assembly and Senate, to generate $1 billion in one-time revenue. But the sales were part of a gimmick: No buyer stepped forward to purchase the buildings. Instead, the state issued more than $1 billion of notes backed by the rents that it will pay on the buildings—at a cost of $1.5 billion over 20 years. The state remains in control of the buildings, and a financial trustee collects the state—s payments and issues checks to buyers of the notes. Since the borrowing is technically being repaid by rents—not tax revenues, as in the case of lottery revenues—Arizona was able to borrow the money despite a provision in its constitution that explicitly limits state borrowing to just $350,000.

States don—t only play the debt game in recessions. To make an annual contribution for public employees— retirements, Illinois borrowed $10 billion in 2003, depositing the sum in its pension funds. But in the boom years that followed, the state still failed to make adequate contributions. So Illinois had to borrow again in 2009, issuing some $3.5 billion in new debt at a cost of $4.5 billion in future principal and interest payments. This year, it borrowed yet another $4 billion for the same reason.

Some budget trickery betrays pledges made by lawmakers to taxpayers. One common example is “sweeps,” when a state shifts money from accounts dedicated to specific purposes, like highway maintenance, into general accounts where the money can be spent on anything.

One honey pot is the tax revenue designated by federal law for upgrading 911 emergency-response systems. An August survey by the Federal Communications Commission reported that states redirected $135 million in these taxes last year to spending for other purposes. New York is a serial abuser: Since 1991, the Empire State has collected an estimated $600 million from its 911 tax. But only $84 million has actually gone to local officials for upgrading emergency services.

These fund transfers have become so routine that New York must now do “reverse sweeps.” For example, New York created a fund 20 years ago to finance bridge and road construction and maintenance. But it often transfers money out of it and into the state—s general accounts—only to replace what—s been swept by borrowing more. About a third of the Dedicated Highway and Bridge Trust Fund—s disbursements, or nearly $1 billion, now goes toward debt service, a figure projected to rise to 70% by 2014. And so New York is shifting tax dollars back from its hard-pressed general fund to help pay off the transportation account—s debt.

In some states, fund transfers have provoked opposition, particularly in cases where the government grabbed money from accounts that are not taxpayer-funded. Since 1975, New Hampshire has operated a medical-malpractice insurance fund financed by physician premiums to provide them with liability protection when they have difficulty obtaining it elsewhere. The fund has built up a surplus of $140 million, and last year the state tried to seize and sweep $110 million of it into its general fund. But the doctors sued, and the state—s Supreme Court blocked the transfer.

Now states are even casting a covetous eye at private bank accounts. This year Michigan decreased the time that money can sit unclaimed in a citizen—s bank account before the state claims it to three years from 15. The state projected the move could provide its general fund with a one-time boost of $200 million.

Early-retirement plans also have turned into budget gimmicks. Michigan recently passed a retirement plan to provide generous additional benefits for up to 6,400 retirees who can step down at age 59. The plan supposedly will save the state—s general fund around $80 million in salaries and benefits in its first year.

Sounds good in theory. But recent history shows the danger of this strategy. In 2002, New Jersey offered an early-retirement plan that 4,000 workers took advantage of. Although it saved the state budget $314 million, the retirement benefits were so rich that they cost the pension system $645 million.

Illinois, meanwhile, passed modest pension reforms earlier this year that apply to new workers. The savings won—t materialize for years—but the legislation included language that allowed the state to calculate the future savings and apply up to $300 million toward closing this year—s budget gap.

Time and again, the quick fix just feeds the spending habit. In 2004, Gov. Arnold Schwarzenegger promised that California could get out of its hole with borrowed money, and voters approved $10.9 billion in deficit bonds. Relieved of its immediate financial squeeze, Sacramento discarded fiscal discipline and went on a binge, hiking spending by nearly a third, or $34 billion, over the next four years. Today the state is back in the hole, facing a $25 billion budget deficit over the next 18 months.

States keep hoping that tax revenues, which began to slump in 2008, will increase significantly and bail them out. But as a report by the National Association of Governors put it earlier this year, states now face “new austere realities.”

In other words: fat chance. This new reality isn—t going away, and elected officials had better wake up to it.

This piece originally appeared in Wall Street Journal

This piece originally appeared in The Wall Street Journal