"Excelsior" or Bust?
FISCALWATCH MEMO March 7, 2005

Governor George E. Pataki says the last four years have been “the worst … since the Great Depression”[1] for New York’s finances.

You wouldn’t know it from looking at the state budget, though. Since the end of the 2001 fiscal year[2], state funds[3] spending has risen 18 percent. That’s a growth rate of one and a half times inflation – despite the fiscal fallout from a national recession, a nasty Wall Street bear market and the destruction of the World Trade Center.

In fact, as explained below, New York State has exerted somewhat less fiscal discipline in the 2001-05 boom-and-bust cycle than during a comparable period in the early 1990s.

Recent state spending trends underscore the high stakes in Albany’s fiscal 2006 budget negotiations. Despite the widespread media focus on “cuts,” especially in health care, Pataki’s proposal calls for net state funds spending growth of 5.5 percent – twice the rate of inflation. If the Legislature is allowed to make significant additions and restorations to the Governor’s budget, New York will be hobbled by state budget shortfalls for years to come.

Déjà vu all over again

Notwithstanding the governor’s frequent allusions to the 1930s, the state’s latest economic and fiscal travails aren’t completely unprecedented. Indeed, there are striking similarities between the early 2000s and the early 1990s. During both periods:

  • New York experienced an economic recession more severe than the national average.
  • Medicaid costs skyrocketed.
  • New York’s budget gaps were closed in large part with tax hikes, increased borrowing and fiscal gimmicks.
  • The Legislature set new records for tardiness in adopting a state budget.

No two economic cycles are exactly alike, of course. For example, the state lost more private sector jobs during the early 1990s, while the revenue losses were much greater after the 2001 recession.

It is possible to compare and contrast the state government’s response to changing economic conditions by looking at budget trends during equal stretches of time that incorporate the “peak to trough” dates of the GDP chart. The last two national expansions ended in July 1990 and March 2001, respectively, and both subsequent downturns lasted for eight months.[4]4 Thus, New York State’s last pre-recession budgets for those periods were enacted in state fiscal years 1990 and 2001 – which are the base points in the chart that follows.

State Spending in Economic Recovery Cycles
Change in State Funds Disbursements in Four Years Following Peak Year

Source: Empire Center calculations based on Executive Budget data

As shown above, the state funds budget rose by 12 percent in nominal terms during the four fiscal years starting with the 1990-91 recession. This amounted to a 5 percent decrease after adjusting for the inflation rate during that period.

During and after the latest recession, by comparison, actual and estimated state funds spending has risen 18 percent. This is a 6 percent increase after adjusting for inflation.

If the budget’s growth in the last four years had been held to the same level as the fiscal 1990-94 period, the state would now be spending $3.4 billion less – equivalent to most of the projected budget gap the state needs to close for fiscal 2006.

The difference

The $10 billion growth in the state funds budget from fiscal 2001 through 2005 has occurred primarily in two categories:

  • Health and social welfare spending has risen by $3.5 billion, including an increase of $2.6 billion in the state’s share of payments to Medicaid providers.
  • Education-related spending is up $5 billion, including $2.1 billion in new aid to public schools, $1.2 billion in STAR property tax relief, and nearly $1 billion for the State University of New York.

While state-funded Medicaid costs have risen 38 percent during the last four years, state Medicaid expenses grew at an even faster rate of 59 percent during the analogous period of the early 1990s.[5] So why has the total state funds budget increase been so much larger in more recent years?

The answer, in large part, can be found in the largest single state-funded category of the budget – education. The total appropriated increase in state-funded General Support for Public Schools from the 2000-01 school year[6] through the 2004-05 school year has been about 12.5 percent – compared to just 7 percent between school years 1989-90 and 1993-94. On a per-pupil basis, the difference is even greater — an increase of 13 percent from 2000-01 through 2004-05 (a period in which pupil enrollment has been flat), compared to less than one percent between 1989-90 and 1993-94 (when enrollment was growing). Adjusted for inflation, state school aid declined in the early 1990s but has kept up with the cost of living since 2000-01.

Contributing to the increase in education-related spending has been the phase-in of the STAR school tax subsidy for homeowners[7], which account for more than one-third of the disparity in total state spending rates between the early 1990s and early 2000s. The program was initiated by Pataki in 1997 and was not fully implemented until fiscal 2002, so it was not a factor in the early 1990s.

Another difference between the early 1990s and 2000s has been the extent to which the state budgets for those periods have relied on reductions in the state payroll.

Cuomo added 30,000 positions to the state workforce and granted unions significant pay hikes during his first eight years in office. But once New York’s economy began to lag, he reversed course and cut 18,000 state jobs through a combination of layoffs and attrition. He also forced employees to absorb $135 million in wage deferrals, although this only amounted to a temporary cash-flow savings for the state.

Pataki, by contrast, relied on attrition to slash the workforce he inherited from Cuomo by 20,000 positions during his first 18 months in office, but has shielded state employees from feeling the brunt of more recent fiscal pressures. Without any layoffs, Pataki has eliminated another 2,000 positions since the end of fiscal 2001. However, the state government headcount is scheduled to rise slightly under the governor’s budget for fiscal 2006.

Although state workers in the most recent post-recession period went a year without a pay raise, as they also did under Cuomo in the early 1990s, they have not lost money to furloughs or payroll lags. And state workers’ base salaries have risen somewhat faster during the most recent four years — roughly 9 percent from April 2001 through the next scheduled hike in April 2005, compared to 8.2 percent between 1990 and 1994. Adjusting for inflation, state workers clearly made larger sacrifices during the budget cutting of the early 1990s.

The veto saga

The key fiscal turning of recent years came in early 2003, when Pataki unveiled a fiscal 2004 budget designed to hold the line on overall state spending while substantially reducing projected out-year deficits. That budget included a series of Medicaid “cost containment” actions along with a $650 million school aid cut, which was summarily rejected by the Legislature. Overriding the governor’s vetoes, Senate Republicans and Assembly Democrats agreed to add or restore $2.2 billion in state funds spending, financed in part by large temporary increases in personal income tax and sales tax rates. Those tax increases are supposed to expire this year – although some legislators have joined labor unions in pushing for their extension.

Here, again, there was a parallel with the early 1990s. In May 1991, Cuomo vetoed nearly $1 billion in legislative spending additions to his budget. Faced with a potential override, however, he negotiated an agreement to raise taxes and restore many of the vetoed spending items.

However, the tax increases passed by the Legislature over Pataki's veto in 2003 were larger, in both absolute terms and as a percentage of the budget, than those imposed under Cuomo to close budget gaps in the early 1990s.[8] In other words, it’s been possible for state spending to grow faster during the latest recession and recovery period because, as a result of the tax hikes, there was more money to spend.

Filling the gap

To fill the gap between spending and recurring tax revenues, the state has increased its reliance on “miscellaneous receipts,” including fees, fines, college tuition, lottery profits and bond proceeds. This non-tax category of the budget has risen from 18 percent to 26 percent of state funds spending in the last four years.

"Excelsior" Through Thick and Thin

* Miscellaneous Receipts include State Lottery revenues, SUNY and CUNY tuition payments, proceeds of bond sales, and various dedicated user and licensing fees. FY 2004 only includes special federal grants of $624 million.

Source: Empire Center calculations based on Executive Budget data

But relying on revenues other than taxes creates its own problems, especially when spending is not under tight control. Some miscellaneous receipts are non-recurring “one-shots,” which must be replaced in succeeding years. Others don’t grow automatically with the economy, as income and sales taxes do. The increased reliance on miscellaneous receipts is a way of postponing the inevitable choices to either permanently scale back spending or permanently raise taxes.

Same old problem

A strong case can be made for the argument that, having allowed state government to take on much more fat during the boom years of the 1980s, Cuomo had more room than Pataki to cut once the economy turned sour. The fact remains, however, that school districts and state workers sacrificed more during the fiscally stressed early 1990s than they have during the similarly troubled 2001-2005 period.

Pataki was able to build up a surplus of over $3 billion even while allowing spending to increase at a healthy pace from 1998 through 2001. But the state’s reserve funds were depleted to allow the budget to keep growing even while the economy was shrinking, starting in the fall of 2001. Even renewed growth in tax revenues since 2003 hasn’t been enough to close budget gaps projected at between $2.5 billion and $5 billion over the next three years.

Left unchecked, the rate of state spending would accelerate starting in fiscal 2006, according to the Governor’s latest budget proposal. The baseline state funds budget is on track to grow by another 23 percent over the next three years, if further cuts are not made in each of those years. Legislative additions will boost projected spending even higher.

The state’s persistent structural budget gaps point to one final similarity between the early 1990s and early 2000s: in both cases, the underlying problem is not a lack of revenue but an excess of spending. The gaps of the early 1990s weren’t finally closed until Pataki reduced spending (and cut taxes to spur the economy) during his first three years in office. The current problem can only be permanently fixed with a similar approach.

Notes

  1. This statement by the governor, repeated in the budget message and numerous extemporaneous remarks, is based on the fact that, in 2002 and 2003, state tax revenues declined for two consecutive years for the first time since the Depression.
  2. New York State’s fiscal years run from April 1 through March 31. For simplicity’s sake, fiscal years are defined in this memo by their end dates – thus, for example, “fiscal 2006” means the fiscal year starting April 1, 2005.
  3. The New York State budget reports spending in three ways. The “all funds” total includes federal aid. The “general fund” consists solely of state taxes and fees whose use is not restricted to any purposes or category of spending. But over the past 20 years, the general fund has shrunk from nearly two-thirds to less than half the total budget. For comparative purposes, the best current available measure of spending is the “state funds” total, which includes all appropriations supported by state taxes and fees, excluding federal grants.
  4. The National Bureau of Economic Research identified July 1990 and March 2001 as business cycle “peaks.” NBER provides the following definition: “A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades.” (For more, see “The NBER’s Recession Dating Procedure,” report of the Business Cycle Dating Committee, October 21, 2003, at http://www.nber.org/cycles/recessions.html.)
  5. The Medicaid growth rate for the early 1990s is based on annual figures from 1989 through 1993, respectively, as reported in the state health department’s Statistical Supplement; directly comparable state funds budget figures are not available prior to 1995, but the annual rates closely respond to overlapping fiscal year growth rates.
  6. School year aid appropriations principally reflect funding approved as part of the state budget for the overlapping state fiscal year – i.e., appropriations for the 1993-94 school year would have been made principally in the state fiscal year ending March 31, 1994.
  7. In New York City, a portion of STAR aid is used to finance a reduction of two-tenths of a percentage point in the city resident income tax.
  8. For more details, see “Tax Hikes in Historical Perspective” at http://www.nyfiscalwatch.com/html/fwm_2003-04.html#notes

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