January 21, 2014
Stanford experts urge major reforms in state, local government budgeting
Stanford scholars say states are disguising deficits and must reform their budgeting and financial reporting practices. Otherwise, funding will be scarce for key state and local functions such as education, transportation, health, environmental protections and emergency services.
By Clifton B. Parker
Stanford experts contributed to a report recommending measures to ensure solvency for state and local governments. (Photo: Shutterstock
States must fundamentally reform their budgetary practices to meet the future public needs of their citizens, according to new research.
The report issued by the State Budget Crisis Task Force included contributions by experts from the Stanford Institute for Economic Policy Research – David Crane, a research scholar and Stanford lecturer on public policy, and former U.S. Secretary of State George Shultz, the honorary chairman of SIEPR.
Crane and Shultz joined the others in examining state and local fiscal challenges in six U.S. states: California, Illinois, New Jersey, New York, Texas and Virginia. At stake, the report maintains, are the most essential state and local services for the next generation – education, transportation, health, environmental protections, plus police, fire and emergency operations.
"This report should be read by everyone who cares about future generations," Crane said. "Its principal recommendation – that states adopt accrual-based budgeting – will stop governments from reporting surpluses when they have deficits and elected officials from putting off until tomorrow what they should do today."
Crane's research covers government accounting, pension funding, government finance and investment policies, political reform and state governance.
As he points out, states are currently permitted to treat borrowed funds as revenue and to ignore the full cost of deferred compensation promises when reporting expenses. Those sorts of actions allow elected officials to report balanced budgets now when they are actually creating debts that must be paid off in the future.
While state and local revenues have mostly recovered from the 2008 financial crisis and subsequent recession, many public services have not kept pace. According to the research, some of the most serious issues facing states include:
• Debt obligations are rising faster than the states' ability to meet them.
• Retirement and health care expenditures continue to escalate at a rate faster than state and local revenues. In particular, many governments have not addressed serious pension shortfalls.
• Federal spending reductions present difficulties for state budgeting.
• Transportation infrastructure funding is inadequate.
• The effect of the new federal health care plan (the Affordable Care Act) is unknown and could pose significant budgetary strains on states.
To ensure greater solvency for state and local governments, the report recommends several measures:
• More accurate budgeting: The current practice of cash-based budgeting obscures financial realities and facilitates gimmicks. Governments need to adopt accrual-based accounting, which will more accurately represent current revenues and costs while reflecting future obligations.
• Long-term planning: Multi-year budget planning would establish more realistic assumptions about revenue and expenses.
• Requiring reserve funds: Reserve funds, often called "rainy day" funds, should be required as a way to replenish budget coffers when tax revenues dip.
• Never treating borrowed funds as revenue: Budgets should not pretend that borrowed funds are a real source of revenue.
• Clear reporting and budget documents: Budgets and financial reports should be readable and accessible for relevant audiences.
• Weighing impact of federal actions: Many federal actions are taken without understanding how those decisions affect state and local governments. Greater coordination between policymakers at all levels would help ensure the sustainable delivery of public services.
Some states have made progress, according to the report, but "the ability of state and local governments to meet their obligations to public employees, to creditors, and, most critically, to the education and well-being of the public is deteriorating."
California is listed among those making budgetary headway. However, "Most states are on a revenue roller coaster, and it will be a bumpy ride for them and even bumpier for their localities."
Paul Volcker, former chairman of the board of governors of the U.S. Federal Reserve System, and Richard Ravitch, former lieutenant governor of New York, established the State Budget Crisis Task Force in 2011 to analyze the fiscal crises at the state and local levels of government.
"The time to act is now," the report read.
For more Stanford experts in economics, public policy and other topics, visit Stanford Experts.