District states struggle with budgets

David S. Dahl | Regional Economist

Published April 1, 1993  | April 1993 issue

The only good budget is a balanced budget.
— Adam Smith, 1776

Ninth District state policymakers, like their counterparts in Washington, D.C., are finding it difficult to live up to Adam Smith's dictum. In their recent budget messages, governors from Minnesota, Montana and North Dakota indicated that during the next two fiscal years their states face budget deficits of $769 million (later revised to $163 million), $337 million and $125 million, respectively. Moreover, in South Dakota, Gov. George Mickelson is proposing a spending increase of 4.2 percent for fiscal 1994, the smallest in a decade.

Deficits not coming from weak economies

This fiscal stress is apparently not coming from weak economies depressing revenues. In December general fund revenue collections for fiscal 1993 in Minnesota, North Dakota and Montana were running 5.8 percent, 2.1 percent and 1.3 percent, respectively, ahead of projections, according to the National Conference of State Legislatures. In South Dakota they were on target. Furthermore, revenues should increase; the district's non-farm economy is expected to expand moderately from the fourth quarter of 1992 to fourth quarter of 1994, according to Minneapolis Fed forecasting models.

Instead, the fiscal stress in the district's four complete states appears to be largely arising from spending pressures. "Service demands will exceed our financial means during the 1990s," said Minnesota's Gov. Arne Carlson in his budget proposal. Governors are reluctant to raise taxes and, instead, they are proposing expenditure cuts and reconsidering how states provide services.

District states are struggling to balance their budgets because of demographic and social trends in the 1980s that caused expenditure increases to continue and, if anything, will cause them to intensify in the 1990s. Between fiscal 1983 and fiscal 1991, which approximates the economy's last expansion, 1980s outlays for elementary and secondary education, social services and public safetywhich account for about 50 percent of district states' general expenditureshave generally been increasing faster than personal income, a proxy for state output. Thus, total state government expenditure growth in all four district states surpassed output growth.

Rising education outlays affect spending ...

The increase in elementary and secondary education expenditures does not appear to have come from expanding enrollments, and recent birth rates suggest no upcoming surge in district school enrollments. Instead, policymakers responded to concerns about educational quality. When asked to assess important issues confronting the region, district business leaders responding to fedgazette polls have repeatedly assigned a high priority to education. The public's concerns have resulted in rising expenditures; between 1984 and 1991 outlays per pupil, adjusted for price changes, increased in Minnesota, Montana and South Dakota and declined slightly in North Dakota.

District governors remain committed to continued improvement in public education. "We cannot allow a tight budget to deter us from implementing innovative ideas to restructure schools, classrooms and curriculum. If we are going to prosper in the next century, we must invest in our greatest resourceour children," said Gov. Edward Schafer of North Dakota.

As do skyrocketing Medicaid costs and ...

Medicaid, a federal-state program providing low-income individuals health care, has driven up social services expenditures, and Medicaid outlays are foreseen rising rapidly in the 1990s, due to increasing health costs, expanding enrollment and new federal mandates. "Unless the health care market is substantially reformed, costs will continue to rise rapidly into the next century," according to the 1993 Economic Report of the President. Meanwhile, the number of Medicaid recipients in South Dakota is expected to double from 32,018 in 1986 to 62,253 in 1994, approximately 9 percent of the state's population. Finally, new federally mandated services accounted for 38 percent of the $32 million increase in Montana's Medicaid costs from 1991 to 1992.

Swelling prison populations

Public safety outlays, which account for only around 3 percent or less of district state government expenditures, have been rising rapidly because of rising crime rates and efforts to "get tough" with criminals by imposing more and longer sentences. District prison populations increased sharply in the 1980s and further increases are foreseen. The male inmate population at Minnesota state prisons is expected to increase from 3,750 in 1993 to 4,500 in 1996, according to Gov. Carlson's budget.

Striving to improve elementary and secondary education, to fund rising health costs and to keep up with swelling prison populations are not the only expenditure pressures on district state governments; other important obligations are funding state colleges and universities and maintaining state highways.

Taxes have increased

To keep up with expenditure increases, state taxes generally have increased somewhat faster than growth in personal income, and in recent years district states have enacted substantial tax increases. South Dakota, however, remains one of seven states without a personal income tax and Montana is one of only five states without a sales tax.

Moreover, federal aid, except for Minnesota, has been rising faster than personal income. However, state discretion in using these funds is limited; in fiscal 1993 in South Dakota, for example, close to two-thirds of federal aid was allocated to funding federal mandates. "Federal mandates will add to spending increases, but federal aid is not likely to keep pace," said state finance expert Steven Gold when speculating on state government finances for the first half of the 1990s, according to the National Tax Journal.

Lotteries are a new revenue source

Because tax and federal aid increases were insufficient to cover rising expenditures, Minnesota, Montana and South Dakota established state lotteries. In South Dakota $54 million is expected from the state lottery in fiscal 1994, which will cover about 70 percent of the state's share of Medicaid payments.

States are reluctant to raise taxes to balance budgets ...

District states are reluctant to increase taxes to resolve this dilemma between inexorable expenditure pressures and strained revenue sources. "Taxes are the poison that will kill job growth," said Minnesota's Gov. Carlson, and North Dakota's and South Dakota's governors agree and are proposing no tax increases. With Montana's expenditures exceeding revenues in seven of the last 10 years, however, the state has run out of temporary solutions, and Gov. Marc Racicot is proposing a 4 percent sales tax.

... but are cutting expenditures and ...

"Based on what I have seen, it's time to punch a hole in our belt and pull it tight another notch," said North Dakota's Gov. Schafer, and he recommended general fund spending cuts in virtually every state agency, including the governor's office. In Montana Gov. Racicot is proposing $83 million in budget cuts, and in Minnesota Gov. Carlson is asking state employees to forego a one-year pay increase. Gov. Mickelson in South Dakota is proposing a budget that meets "the state's basic needs with the money available."

... reconsidering how to provide services

But enacting tax increases and cutting expenditures may not be sufficient to resolve this dilemma, and governors are talking about fundamental changes in how states deliver services. "We must reform," said Minnesota's Gov. Carlson, and "spend smarter." North Dakota's "revised budget reflects my goal of rightsizing government, privatizing some state services, and providing quality, efficient services to people in need," said North Dakota's Gov. Schafer. To reduce administrative expenses, for example, Montana's Gov. Racicot proposes reducing the number of school districts to one per county.