Policy Briefing Addresses State Fiscal Crises

Winter 2004, Volume 26, Number 1

Dawn Clark Netsch discusses the briefing with Therese McGuire and Fred Giertz.

States across the U.S. are facing what seem to be some of the most severe fiscal crises in their histories. They face difficult choices about what to cut, what to fund, and how to increase funding. To address this issue, the Institute for Policy Research (IPR) held a policy briefing, “State Fiscal Crises: Causes, Consequences, and Solutions,” on May 28 in Chicago. More than 60 people attended.

“This fiscal crisis is different from previous ones both in terms of the average state response to the crisis and the severity of the fiscal problem in relation to the economic downturn,” said Therese McGuire, IPR faculty fellow and professor of management and strategy at Kellogg, who organized the briefing.

McGuire, who led the panel of experts, started by debunking some of the myths associated with this fiscal crisis. In contrast to some claims, she argued, the 2001 recession was much milder than the 1990 and 1982 recessions, fluctuations in capital gains contributed to the crisis but were not the main cause of its severity, and choices in tax-and-spend policies were a key factor driving this fiscal crisis.

So, who is to blame for this current crisis? Is it the states themselves who overspent their way into deficit? Iris Lav, deputy director of the Center on Budget and Policy Priorities in Washington, D.C. dispelled this notion, noting that states have increased the amount of money they put in rainy day funds ($12.5 billion in the early 1990s vs. almost $50 billion by 2000) and spending growth in the 1990s was below the post-WWII decades. “The cause of this crisis is really a revenue problem,” she said. Though states put away an average of 10 percent of a year’s receipts, it was not enough to cover such huge deficits. Ideally, she recommended that states should target putting at least 15 percent of state revenues into a flexible state fund. States should have enough in their rainy day funds to weather a three-year downturn on average.

Fred Giertz, professor at the University of Illinois at Urbana-Champaign and executive director of the National Tax Association, noted that “We’ve gone from the best situation in history to the worst situation in two years.” Taking the example of Illinois, the state projected $25 billion in revenue and equal expenditures in early 2002, but instead faced a drastic $1.6 billion drop in revenue. The news for 2003 and 2004 is equally dire. To balance its budget, Illinois would have to cut major programs—closing the state fair or raising casino taxes is not enough. Instead, the state is relying very heavily on short one-time revenue sources, such as Gov. Rod Blagojevich’s $10 billion pension-bond issue. Most states are pursuing such short-term “muddling-through” strategies for raising revenue, he said, because permanent solutions involve lawmakers either making large cuts in popular programs such as education or public aid or raising income and/or sales taxes. “Illinois is doing neither of these right now,” he said. “It’s not solving its budget crisis—it’s just delaying it for one year.”

Obviously, a key to solving some of these fiscal problems would be a business upturn. But the briefing’s moderator, Douglas Whitley, president and CEO of the Illinois State Chamber of Commerce, wondered, “How can we perpetuate jobs, investments, and create an economic engine in our state when those same business leaders, whose costs are going up, are saying, ‘I have to put that next plant in China?’”

There are no easy answers, but one of the attendees, Dawn Clark Netsch, professor emeritus of law at Northwestern and former Illinois state senator and state comptroller, noted that these current crises were not completely unexpected— though more severe than anticipated. She and others have worked for the past 20 years to correct the structural imbalances that caused them. But for real change to occur, she pointed out that Illinois needs “politicians who won’t grandstand,” and the media needs a lesson in how to report fiscal policy and fiscal reform “without turning it into the very political issue that it cannot be if it’s ever going to happen.”