Special Briefing: State & Local Budgets in Uncertain Times

State, Local Budget Officers Gird for Tough Times Ahead

• Record rainy day funds bolster confidence as recession risk rises
• Tight labor markets, expiration of COVID relief, debt ceiling add to worries
• Income Tax Revenue Slips in New York, California
• California needs to close as much as $25 billion deficit
• Colorado sends out rebates under Taxpayer's Bill of Rights

State and local budget officers are facing a raft of risks and uncertainties for fiscal 2024 and beyond from a position of unprecedented strength, according to analysts and budget experts at a Special Briefing hosted by the Volcker Alliance and the Penn Institute for Urban Research.

At the end of fiscal 2022, state rainy day funds reached a record $134.5 billion, or a median level of 11.6 percent of general fund spending, said Shelby Kerns, executive director, National Association for State Budget Officers (NASBO). She said the rainy day funds and other reserves, coupled with improved budget practices following the Great Recession of 2007-2009, will help cushion state finances against the chance of difficult times ahead.

Webinar panelists said budget officers are grappling with, the risk of recession, along with tight labor markets and inflation putting upward pressure on wages. Meanwhile, they will also have to factor in the expiration of federal COVID-19 stimulus; a changing tax base in urban office markets as more people work from home; and the possibility of a global financial crisis if Congress fails to raise the US debt ceiling.

Moderated by William Glasgall, Volcker Alliance senior director, public finance and Penn IUR fellow, and Susan Wachter, co-director of Penn IUR, the briefing was the thirty-ninth in a series of sixty-minute online conversations featuring experts from the national research networks of the Volcker Alliance and Penn IUR, including leading academics, economists, and federal, state, and local leaders.

In addition to Kerns, panelists included Eric Kim, senior director, Fitch Ratings; Gabriel Petek, legislative analyst, State of California; and Lauren Larson, director, Colorado Governor's Office of State Planning and Budgeting.

Fitch sees a deteriorating outlook for state and local governments, Kim said, but remains comfortable about the stability of their credit. “States and local governments have the tools, including things like solid reserves and well managed liabilities, that should allow them to ride out what looks like it could be just a moderate recession,” he said.

Kim said rising sales tax receipts have contributed to a substantial revenue cushion for many states. However, he said, California and New York are reporting declines in income tax receipts, probably related to the collapse of tech sector initial public offerings and reduced bonuses on Wall Street.

“The big question, of course, is whether California and New York are exceptions or outliers, or are they the leading edge in a widespread slowdown or decline in tax revenues,” Kim said. “April collections this year, as they are every year, will be an important part of the answer for us.”

Kim said the unexpected surge in revenue during the pandemic is spurring changes in tax policy, including some that may prove costly, such as proposals in Mississippi and North Dakota to largely eliminate the personal income tax. “Enacting significant tax policy changes amid an uncertain economic environment increases the risk of unexpected consequences,” Kim said.

Kerns said NASBO is confident in states’ ability to weather a recession because of their revenue growth, increased rainy day funds, and total balances that have tripled in size over the past two years to just under 25 percent of general fund spending. States have paid off debt, used surplus funds for capital projects, made supplemental payments to pension funds, and created savings accounts for disaster preparedness, and Medicaid and education spending, she said.

Governor Gavin Newsom’s budget proposal in California reflects an $18 billion deficit, primarily the result of a $30 billion downward revision in revenue estimates, Petek said. The governor’s proposal to balance the budget through $13.6 billion in reductions or delays to scheduled spending and $4.3 billion of cost shifts, is “generally prudent,” Petek said. The Legislative Analyst’s Office, however, estimates the deficit at $25 billion and recommends solutions that would address the deficit without using reserves.

“Our office is not saying that the state should never use reserves,” Petek said. “If after solving the level of deficit that we estimate, the problem has gotten worse or the economy has gone into recession, we would say that that is really the time to use reserves,” he said. “The reserves are really there to support core baseline spending.”

Larson said Colorado’s revenue was up 24 percent last year, exceeding the pre-pandemic trend. The state has built reserves to a record level of about 15 percent of general fund spending, she said, while sending rebate checks of $750 per individual in 2022 under the 1992 Taxpayer’s Bill of Rights Amendment. A round of $250 checks is coming in the spring, Larson said, and an additional $600 rebate is under consideration.