Q: AND A:
The endless stream of reports on state and local finance tend to have three things in common: They focus on bad news. They look at just one layer of government. And they are written by groups representing the governments they write about.
Few agencies, either public or private, look at government finance in the United States as a whole. The U.S. Advisory Commission on Intergovernmental Relations does.
Recently, it released the latest editions of two periodic reports on the state of government finance.
One report, "Significant Features of Fiscal Federalism," is released annually. The report follows revenue and spending trends on the local, state, and federal levels. It also follows the fiscal interrelationships of these three layers of government.
The other report, "RTS; State Revenue Capacity and Effort," is released every two years. The RTS, or Representative Tax System, report evaluates the relative wealth of states by looking at their ability to levy taxes. The commission says taxing ability is a more practical method of comparing wealth than more conventional methods such as comparing per capita incomes between states.
Philip Dearborn, who is the commission's Director of Government Finance, Research, supervised the completion of these reports. He was formerly the director of finance for both Lakewood, Ohio, and Cleveland, Ohio. Dearborn was also the budget director of Fairfax County, Virginia, and a budget analyst for the U.S. Office of Management and Budget. A former vice president of the Greater Washington Research Center, he now lectures on public finance at Howard University in Washington.
Here, Dearborn discusses the findings of the two reports with staff reporters Dean Patterson.
Q: What do you think is the most significant trend in state and local finance so far in the 1990s?
A: Without question, I would say it is the sharp increase in federal grants and aid to states. That is a clear change from the trend we experienced starting in 1978, going through the Reagan years, and ending in about 1989. In 1990, grants began to increase quite rapidly by whatever measure you would want to use -- constant dollars, nominal dollars, or percent of gross domestic product.
Q: So the trend reversed during the Bush years. Why?
A: One obvious reason is that health-care spending soared. The recession made more people eligible for Medicaid. Health-care costs experienced high inflation. And provider taxes enabled states to maximize federal aid on Medicaid. Also, non-medicaid grants to states increased 8% per year on average.
Q: What about the common complaint from states that they are being inundated by unfunded federal mandates?
A: There are two reasons why mandates are not directly related to federal aid. First of all, in many instances mandates are separate from actual federal aid. For example, there are many federal mandates dealing with environmental requirements. But a relatively small amount of federal aid goes to states for the environment. And second, much of the increase in federal aid came in the form of funds that go directly to individuals -- transfer payments.
Q: What about the flow of federal money to local government?
A: Another thing that's apparent is local governments are getting a decreasing amount of federal aid. To the extent that federal mandates affect local governments, they are not being funded at all by federal money. Federal funds going to local governments have been declining since 1978. For example, in 1978, local governments received 28% of the federal aid pie. By 1991, their share was down to 12%.
Q: What is causing this trend?
A: One of the biggest reasons, of course, was the demise of general revenue sharing. That wiped out the biggest program for local governments. The other major reason is that federal aid to states increased so much that it pushed down the proportion going to local governments.
Q: Is there a discernible trend in state funds going to local governments?
A: Yes. There has been a very substantial increase in state payments going to local governments. In nominal terms, it has grown from $82 billion in 1980 to $186 billion in 1991. Most of the increase has come from funding for education. I think there has been a substantial shift, in that states, rather than local governments, are paying more and more of the education bill.
Q: What are some of the important trends in state tax revenues?
A: State income tax revenues have been rising much more rapidly than sales tax revenues. In general, we think of sales taxes as a growing revenue source for states. And there has been a lot of talk in many states about broadening the sales tax base. But actually, most of the increases have come from a minor broadening of a few services and from rate increases.
In contrast, personal income tax revenues have grown rapidly and have more than kept pace with growth of the economy. In fact, from 1972 to 1991, personal income tax revenue grew twice as fast as sales tax revenues.
Q: What has been happening with state and local debt in relation to federal debt?
A: From 1980 to 1991, total federal debt almost doubled -- it went from 33.8% of gross domestic product to 65%. Meanwhile, total state debt went from 4.5% to 6.1% of GDP, about a 50% gain. And local debt went from 7.9% to 10.1% of GDP. So there has been an increase across the board in government debt. But federal debt accounted for most of the gain.
Q: What do you think caused local debt to increase in those years?
A: Part of it, I think, can be accounted for by how local debt. is classified. There's a lot of quasi-private purpose debt mixed in there now for things like convention centers, sports stadiums, and a whole range of housing projects. Other statistics show there has been a big expansion in revenue bonds. There's also been some increase because of the recent wave of refundings.
In 1959 and 1964, local debt was higher as a percent of GDP. It has been up and down through the years. It depends a lot on interest rates. For example, 1980 is a relative low point for local debt. This is because interest rates were very high then.
Q: What about the recent upward trend in state debt?
A: State debt has gone up pretty rapidly. A lot of states that didn't borrow in the past now have begun to borrow. A lot of states are borrowing to forward-fund highway projects. But as with local debt, if you look at state debt over several decades, it's stayed pretty stable.
Q: Why is that?
A: Unlike the federal government, state and local governments generally don't finance their annual operating budgets. And since their long-term debt needs do not change much, I think the growth of their debt in recent years primarily reflects inflation. And these private-use bonds are adding a little bit on the margin.
Q: Have state and local governments fully recovered from the recession?
A: We don't have complete numbers. Nonetheless, the general situation is as confusing now as it was a few years ago. One concern is, how do revenues come in relative to what state and local governments anticipated? In 1992, a lot of state budgets were thrown into deficit because states overestimated revenues. This forced them to raise taxes and cut spending.
What we have now seems to be the opposite situation. States are now very conservative with their estimates. We don't have hard numbers to show us this. But it seems that now states are generally exceeding their revenue estimates.
Q: Will these surpluses show up in states' yearend balances?
A: Well, some states went so far in the hole that it will take them a few years before we see their ending balances come up. But in general, I think the ending balances will show a sharp upward shift in 1993.
Q: Is there much of a delay between a recession and when it shows up in state and local financial data?
A: It's hard to generalize. This recession was considerably different from the recession of the early 1980s. That recession was much deeper, but the recovery came very fast. It gave states no particular problem because their revenues rebounded quickly. The latest recession, while not as severe, gave states more trouble because the economy has been slow to recover.
Q: Could you characterize what the 1990s might be like for state and local finance?
A: Much of it will depend on what happens with health-care reform. States, in particular, have been overwhelmed by health-care costs for Medicaid and their own employees. Local governments have experienced similar problems. The 1990s will be okay if health-care reform provides some relief or at least slows the growth down to single digits. In general, state and local revenues have been stable and their spending has been economical. I think without exception around the country, states and cities are becoming better managed.
Q: Why do you think that is?
A: Partly, it was the shock of what happened with New York and Cleveland in the 1970s. This created an awareness of the danger of mismanagement. There has also been a new breed of state and local politician that built their reputation around their ability to manage, as opposed to delivering services to certain groups.
Q: Are there any other trends you want to describe?
A: Yes. Our Representative Tax System report shows that states have been moving closer together in terms of their relative wealth. It means there is less of a difference between our richest and poorest states. This means there is less of a need for federal equalizing aid.
Q: Is that because less developed states have grown more than more developed states?
A: No, unfortunately. It resulted more from the wealthier areas, including the Northeast, Mid-Atlantic, and West Coast areas not doing as well as they did in the past. But at the same time, other areas did improve.
