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Observation: Now What? Tough Road Ahead for New Governors November 2010

Now What? Tough Road Ahead for New Governors

By John F. Cape
Senior Fellow, the Rockefeller Institute of Government

John Cape

One of my favorite movie lines is delivered by Robert Redford at the end of the film “The Candidate.” Having just won election, Redford’s character asks, “What do we do now?”



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John F. Cape is a senior fellow at the Rockefeller Institute and managing director at the PFM Group, where he specializes in state- and local-government finances and policy. He previously served as budget director for New York State, and is a 34-year veteran of New York State government.

With 37 states’ chief executive officers chosen this Election Day, many of the nation’s newly elected governors may be awakening with a similar thought. Across the country, governors will be preparing their 2011-2012 budgets, or seeking modifications to the two-year fiscal plans already in place. Despite campaign promises to “rein in spending” or “run the state like a business,” as new administrations look to the nitty-gritty work of building balanced budgets around those laudable goals, they will be faced with a series of stark realities:

  • Significant portions of state spending are beyond their control. Payments for debt service (a growing factor in many states), pensions, and varying levels of entitlements that are driven by federal mandates or state constitutional requirements, are all virtually “uncuttable.”
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  • The majority of the remaining “cuttable base” resides in health care and education.  These two program areas — including Medicaid and public health, as well as pre-K through 12th grade public education and the state university systems — typically represent two-thirds to three-quarters of state operating funds after debt and benefit payments are excluded. 
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  • There is little, if any, “low-hanging fruit.”  States have drawn down reserves, swept balances from dedicated funds and used up most other relatively noncontroversial budget solutions. 

They’ve also already made cuts in core programs. Across the country, with few exceptions, programs such as Medicaid have been the target of aggressive cost-cutting measures for the last several years. As policymakers look for further cuts, the facts are sobering: in most states, over three-quarters of all Medicaid expenditures go for one of the “Four Ds”:

  • Dying — palliative care in the last six months of life;
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  • Disability — largely institutional and community-based programs for behavioral health and developmental disabilities;
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  • Dementia — care for elderly who require nursing home or other significant levels of care; and
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  • Drugs — the cost of prescription medications, including high-cost items such as atypical antipsychotics (drugs used to treat individuals with serious and persistent mental illness) and anti-retrovirals used to treat people with AIDS and HIV. This last category has become less prevalent with the advent of Medicare Part D, which pays for prescription drugs for older low-income individuals eligible for Medicaid and Medicare.

Beyond those big areas, steps such as reducing optional services and increasing co-pays only impact the programs’ costs at the margins.

Moreover, most of the money in Medicaid goes to very few recipients. According to the federal Centers for Medicare & Medicaid Services, over 57 percent of all Medicaid spending is attributable to just 5 percent of recipients. The chronically ill drive a huge component of health-care costs.

As stimulus monies provided through the American Recovery and Reinvestment Act come to an end, state and local costs for Medicaid, public schools and, in some cases, public higher education will rise. While states are seeing modest revenue growth, the fragile and anemic economic recovery will mean that state revenue growth is unlikely to compensate for the federal aid reductions, much less normal cost growth.

Because they have been able to use federal stimulus funds, local school districts have a higher expenditure base than their state and local resources would permit. As these funds phase out or go away entirely in fiscal 2011-12, school cost-containment actions will undoubtedly put additional pressure on statehouses for relief.

Against this bleak background, in most areas of the country, state government has effectively lost its pricing power. In race after race, gubernatorial candidates — Republicans and Democrats alike — have rushed to assure voters that they have no intention of raising taxes. As a result, given the inherent lag between economic recovery and state revenue growth, it is likely that many states will be mired in difficult fiscal conditions until 2013 or 2014.

So, what should state leaders do? From my experience over the past 35 years working as a state budget official and consulting for state fiscal managers across the country, I would offer new governors two simple suggestions:

  1. Define fundamental goals for your major programs and revenue sources to be achieved by your fourth year in office.
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  3. Have your budget staff do a “back of the envelope” calculation of the Year Four costs of those spending goals and the monies potentially generated by your Year Four tax goals, and see how closely they match. These are estimates, so they don’t have to balance perfectly — they just have to be close.

If you want to be the “tax-cutting education governor” (and who doesn’t?), this exercise should be eye-opening. Unless you’re in North Dakota (which has been spared most of the current economic pain), it will likely require you to repeat step one. Once affordable long-range strategic objectives are defined, then you should begin work on the upcoming fiscal plan.

Simply put, the fiscal stress in the coming years will make state budgets very unforgiving of mistakes. Embarking on spending or tax strategies that are unsustainable can result in painful course-reversals later.

This planning will not be easy or pretty. Suffice it to say that the next few years will see a greater debate about the fundamental role of government — at all levels — than we have had in 50 years. State programs and agencies that have survived untouched for years could face elimination or consolidation. Non-core assets such as real estate or liquor stores could be put on the sales block. Surely, we will see a restructuring of state and state-subsidized employee benefit programs to realign with broader labor market norms. And the result of those debates will color state fiscal plans going forward for at least a decade.

In short, successful governors will have to make hamburger out of what have previously been sacred cows, or risk seeing their agendas trampled by the herd.


ABOUT THE ROCKEFELLER INSTITUTE OF GOVERNMENT

The Nelson A. Rockefeller Institute of Government, the public policy research arm of the State University of New York, conducts fiscal and programmatic research on American state and local governments. It works closely with federal, state, and local government agencies nationally and in New York, and draws on the State University’s rich intellectual resources and on networks of public policy academic experts throughout the country.