Study: States don't need bankruptcy option

By Jamey Dunn

A new study says doom-and-gloom news stories predicting that states will default on their debts are overblown and draw attention away from the need for long-term reforms.

The report was released today by the Center on Budget in Policy Priorities (CBPP) — a Washington, D.C.-based think tank that studies state and federal fiscal decisions that affect low- and moderate-income families and individuals. It acknowledges that many states and municipalities are struggling to overcome large deficits, partly because of falling revenues caused by the recent recession.

According to the center, states face a total shortfall of $125 billion for fiscal year 2012. The report says state governments are taking steps to address their deficits, such as often-unpopular cuts and tax increases. “While these deficits have caused severe problems, and states and localities are struggling to maintain needed services, this is a cyclical problem that ultimately will ease as the economy recovers.”

Iris Lav, one of the authors of the study, said states should be able to solve their budget problems without resorting to bankruptcy. “They have a lot of internal pressure [to make cost-saving changes]. They have resources, they have taxes, they have the potential for cutting spending if they need to.”

Lav, former deputy director of the CBPP and now a senior adviser to the organization, said the potential for bankruptcy might take pressure off of states to address some unpopular issues “The political process will be more difficult [with default as an option] … and there’s not evidence that it’s necessary.”

The report says lumping pension and borrowing debt into the immediate operating funds shortfall is the wrong approach because states have more time to solve such problems as under-funded pensions. “Unlike the projected operating deficits for fiscal year 2012, which require near-term solutions to meet states’ and localities’ balanced-budget requirements, longer-term issues related to bond indebtedness, pension obligations and retiree health insurance … can be addressed over the next several decades. It is not appropriate to add these longer-term costs to projected operating deficits.”

Lav said some media reports claiming that states have a total of $3 trillion in unfunded pension liabilities are are based on the notion that states will make nearly risk-free pension investments from now on, which she says is not the case. The study estimates the unfunded liability is “a more manageable (although still troubling)” $700 billion.

She added that many states, including Illinois, have taken steps to cut future pension costs, and more will likely follow suit. Lav thinks states will also start cutting some health benefits for employees or requiring them to pay more for their insurance coverage because health care costs are outpacing both the growth of the economy and state revenues.

The report's authors cite Illinois as an outlier state facing more extreme short- and long-term problems. “Illinois also has one of the worst structural deficits in the country,” said Nick Johnson, director of the State and Fiscal Project for the CBPP.

The study describes the pension systems of Illinois, New Jersey, Pennsylvania, Colorado, Kentucky, Kansas and California as “grossly underfunded.” While most states will have to increase average pension spending from 3.8 percent of their operating budgets to about 5 percent, the study says these states will likely have to take more drastic measures.

The study makes several recommendations for states seeking to get their budgets in order:

• Expand the sales tax base to services to capture the economic shift from manufacturing to service industries.
• Create a progressive tax system as opposed to a flat income tax rate.
• Create five-year-plan budgets based on accurate revenue projections, so lawmakers can see the future impact of today’s choices.
• Allow breaks for seniors only on a need basis instead of doling them out to all residents past a certain age.

The study cited Illinois as an “extreme example” of “failure” to address such fiscal and budgeting issues: "Because Illinois is chronically short of the revenues it needs to cover its expenses, it has engaged in a number of poor fiscal practices over the years. It has postponed payments to vendors, failed to make adequate pension contributions or borrowed money to make the contributions, securitized or sold assets, and taken other dubious actions. As a result, it has had a particularly difficult time coping with revenue declines during this recession, with a fiscal year 2012 deficit projected to equal half of its general fund budget, and has developed an large overhang of longer-term debt and unfunded liabilities."

Lav said Illinois lawmakers took a necessary step in passing an income tax increase. She said, however, that Illinois is “essentially paying the penalty for its failure to address its revenue situation over and over again for a number of years.”