STATE BUDGET SHORTFALLS AND BUDGET BALANCING STRATEGIES DURING AND AFTER THE GREAT RECESSION OF 2008 Yu Shi*

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1 J. OF PUBLIC BUDGETING, ACCOUNTING & FINANCIAL MANAGEMENT, 28 (1), SPRING 2016 STATE BUDGET SHORTFALLS AND BUDGET BALANCING STRATEGIES DURING AND AFTER THE GREAT RECESSION OF 2008 Yu Shi* ABSTRACT. This paper investigates how state governments used budget balancing strategies to cope with budget shortfalls in the fiscal years between 2009 and Using data from the Fiscal Survey reports and Comprehensive Annual Financial Statements (CAFRs) covering all fifty states, the paper summarizes and analyzes several types of strategies such as state savings, federal aid, revenue enhancement and expenditure cutting in response to budget shortfalls during and after the Great Recession of In addition, findings from the three case studies in New York, Texas and Washington show distinct patterns in these states choices of balancing strategies to cope with budget shortfalls. New York adopted a more balanced approach between revenue increasing and expenditure cutting strategies, whereas Washington and Texas implemented more severe expenditure cutting strategies to address budget shortfalls. INTRODUCTION This study explores how states responded to budget shortfalls and compares different budget balancing strategies during and after the Great Recession of Budget shortfalls are commonly known as the fiscal condition in which state government revenues are short in providing for the cost of its promised services. Unlike prior economic recessions, the most recent fiscal crisis severely strained state budgets starting from Fiscal Year (FY) 2009, and conditions in almost all states became even worse in FY 2010 and FY States * Yu Shi is a Ph.D. candidate, Department of Public Administration, University of Illinois at Chicago. Her teaching and research interests are in public budgeting and financial management of state and local governments in the US. Copyright 2016 by PrAcademics Press

2 STATE BUDGET SHORTFALLS AND BUDGET BALANCING STRATEGIES 27 faced huge fiscal challenges to make up for large budget shortfalls of historical standards. The total amount of budget shortfalls at the state level accumulated to approximately $190 billion in FY There is a broad array of budget balancing strategies available to state governments in response to budget shortfalls, such as state savings, revenue increasing and expenditure reducing strategies. The question remains whether there are different patterns in budget balancing strategies between states. This study contributes to previous literature on this topic by conducting an in-depth study of state budget balancing strategies and comparing the different strategies taken by three individual states (New York, Texas and Washington) to close budget shortfalls in the context of the Great Recession of Based on data collected from the Fiscal Survey of States reports, this in-depth study on strategies used by 50 states during and after the recession finds four primary types of budget balancing strategies. In addition to using the textual materials from Comprehensive Annual Financial Reports (CAFRs), this paper includes case studies of three individual states dealing with budget shortfalls to focus on their choices of budget balancing strategies during and after the economic downturn in These three state-level case studies usefully complement the findings on different types of strategies and conclude that distinct patterns in budget balancing strategies exist across states. For state governments, the use of a balanced approach between revenue actions and expenditure strategies is more likely to significantly reduce budget shortfalls than the use of expedited balancing strategies such as drawing on rainy day funds, budget cuts and targeted cuts. The article is divided into five sections. The first section is a brief literature review of budget shortfalls and state government responses to fiscal problems. The second section consists of a brief description of datasets and research methods. The third section presents an indepth study of the different budget balancing strategies in 50 states as well as a summary of the major findings. The fourth section comprises case studies of strategies taken by three individual states- New York, Texas and Washington. The final section summarizes the results and insights, and discusses future research.

3 28 SHI LITERATURE REVIEW The literature on state budget deficits and budget balancing strategies of the past two decades can be categorized into two major streams. One stream consists of empirical or comparative analyses of state budget stabilization funds, also known as rainy day funds. The other stream of research relies on case studies to investigate the impact of budget shortfalls and governmental responses to such shortfalls as well as underlying budgetary issues during the state budget process. Compared to other budget balancing strategies, making use of a rainy day fund is the short-term measure commonly taken by states because it is easier to access such funds and less visible to the public. The majority of state governments are legally required to make annual deposits into budget stabilization funds during periods of budgetary stability and economic growth. Drawing on a rainy day fund can be considered to be a minor operation made by states, especially when a budget deficit is expected to be short-term (Lee, Johnson and Joyce, 2008). Moreover, evidence from empirical research during previous economic recessions indicates the effectiveness of rainy day funds in reducing fiscal stress (Sobel and Holcombe, 1996; Douglas and Gaddies, 2002). Despite their potential usefulness, a number of factors may inhibit the use of rainy day funds by state governments to alleviate the impact of a financial crisis. Gold (1995) presents a number of case studies to analyze how various states coped with fiscal problems during the economic recession of the early 1990s. He found that rainy day funds were useful for only some states to alleviate fiscal stress because most states lacked the political will to make the funds large enough to provide much of a budgetary cushion (p.372). In fact, not only do the presence and size of funds but also the structure, legal authorization, and their deposit and withdrawal methods matter for the use of such rainy day funds during economic downturns (Sobel and Holcombe, 1996; Thatcher, 2008). If any of these factors restricts the use of a rainy day fund, the power of such rainy day funds to address pessimistic revenue projections could be affected during an economic downturn. Many case studies have been conducted to provide insight into the individual experience of different states during economic recessions. For the economic recession of the early 1990s, examples

4 STATE BUDGET SHORTFALLS AND BUDGET BALANCING STRATEGIES 29 of such case studies include California (Savage, 1992), Tennessee (Barney, 1992), and New York (Brecher, Horton & Mead, 1994). Examples for the recession during the early 2000s include Wisconsin (Conant, 2003), Georgia (Lauth, 2002), and Missouri (Qiao, 2006). The focus of these case studies is on the structural imbalance of respective state budgets and on attempts by state governments to address budgetary problems. Budget deficits in a number of states during the Great Recession of 2008 have been analyzed in case studies, including New York (Bifulco & Duncombe, 2010), Virginia (Conant, 2010), Connecticut (Mark, Robbins & Simonsen, 2010), Illinois (Bunch, 2010), and Massachusetts (Wallin & Snow, 2010). These studies discuss the magnitude and nature of respective state fiscal problems and the factors causing the severity of budget shortfalls. Moreover, these case studies illustrate how proposed or enacted governmental responses to budget shortfalls vary across states. For example, Massachusetts relied on a one-time reserve to cover the budget shortfalls for FY Virginia not only drew on its rainy day fund and other reserves to offset revenue losses but also cut spending to maintain a structural balance. Both New York and Illinois took taxrelated actions to increase revenues. Although New York adopted increased income tax rates for higher earners, the Governor of Illinois proposed to increase the personal income tax rate from 3% to 4.5% with an increase in the personal exemption from $2000 to $6000 per person. These case studies of individual states help understand the specific strategies taken by each state to address budget shortfalls and alleviate fiscal stress. The purpose of this paper is to discuss various types of state budget balancing strategies, present case studies of three specific states and compare the various strategies used by different states to close budget shortfalls during and after the Great Recession of Unlike previous case studies, this paper has no intention of exploring the structural imbalances of state budgets or the causes of budget deficits for individual states. Although previous case studies provided detailed descriptions of how individual states handled their budget deficits in FY 2009 and FY 2010, none of these studies compared the strategies taken by different states or further investigated how this variation affects the ability of states to reduce or close budget shortfalls.

5 30 SHI DATA AND RESEARCH METHODS The Fiscal Survey of States and Budget Processes in the States is a series of reports published by The National Association of State Budget Officers (NASBO). It serves as the primary data source for this paper. NASBO gathers data on state budget balancing strategies and financial indicators (e.g., general fund expenditure) from all 50 state budget officers, and compiles state-level reports. Data on the total amount of state budget shortfalls in FY 2009 to FY 2013 are collected from the Center on Budget and Policy Priorities (CBPP). This paper measures budget shortfalls as the share of budget shortfalls in general fund expenditure for each state. NASBO and CBPP data are used in the descriptive analysis of the relationship between the number of budget balancing strategies and the severity of budget shortfalls and in the discussion of different types of state budget balancing strategies. The textual materials collected from Comprehensive Annual Financial Reports (CAFR) provide important information for the discussion of the major actions taken by states and for the case study analyses of New York, Washington and Texas. VARIOUS TYPES OF STATE BUDGET BALANCING STRATEGIES It is important to examine the variety of strategy types that states adopted to fight deficits during and after the recession. Table 1 presents the number and percentage of each budget balancing strategy derived from the Fiscal Survey of States reports. These strategies can be categorized into the following four types: state savings, intergovernmental aid, revenue increasing strategies and expenditure reducing strategies. Below, this paper will provide indepth explanations of each category. State Savings Facing severe budget shortfalls during the 2008 economic recession, the mere existence of rainy day fund did not allow states to avoid revenue actions and expenditure strategies. In times of strong economy, states put excess money aside for use in times of unexpected budget shortfalls. The state s savings or financial reserves, often named budget stabilization fund or Rainy Day Fund, are expected to help governments continue necessary services and allow states to avoid tax increases that might

6 Programmatic Strategies Expenditure Strategies Revenue Strategies STATE BUDGET SHORTFALLS AND BUDGET BALANCING STRATEGIES 31 exacerbate an economic downturn (Maag and Merriman, 2007). Table 1 shows that in most of states, rainy day funds are usually used at the very beginning of an economic recession. Table 1 also shows that a number of other strategies besides using the rainy day fund are employed by state governments to cope with budget shortfalls. For example, 26 states and 23 states used rainy day funds for immediate actions in FY 2009 and FY 2010, respectively. Nevertheless, the number of states using such reserves dropped significantly after FY TABLE 1 Number and Percentages of Types of Strategies, FY2009-FY2013 Fiscal Years N % N % N % N % N % Access Rainy Day Fund Enacted Tax Revenue Actions User fees and/or Other Fees Lottery/ Gambling Expansion Subtotal Across-thebroad Cuts Targeted Cuts Reduce Local Aids Subtotal Agency Reorganization Privatization Subtotal

7 Personnel Strategies 32 SHI TABLE 1 (Continued) Fiscal Years N % N % N % N % N % Salary Reductions Benefit Cuts Early Retirement Layoffs Furloughs Subtotal Other Strategies Total Number of Strategies Data source: National Association of State Budget Officers, from FY 2009 to FY From FY 2009 to FY 2013, the use of rainy day funds accounted for less than 10% of total state budget balancing strategies (Figure 1). It is clear that states employed other revenue actions and expenditure strategies besides using rainy day funds to resolve their budgetary issues. To a large extent, this result indicates that the use of rainy day funds cannot fully cover budget shortfalls, and that such funds generate one-time revenue for short-term use only. Although several states have rainy day funds, the use of such funds is restricted by certain conditions for a number of states. In other words, states might face barriers that prevent them from using these funds during an economic recession. As shown in the literature review, a number of factors such as legal authorization and the structure of the fund itself limit the use of state savings. According to the CAFRs, a supermajority vote in the legislature can become one of the critical factors that might prevent the use of rainy day funds. For example, Texas had substantial amounts of money deposited in a rainy day fund, yet its legislature was reluctant to use these funds to

8 Percent% STATE BUDGET SHORTFALLS AND BUDGET BALANCING STRATEGIES 33 FIGURE 1 Percentage of Types of Strategies, % 60% 50% 40% 30% 20% 10% 0% Year Rainy day fund Revenue strategies Expenditure strategies Programmatic strategies Personnel strategies Other strategies cover budget shortfalls and this led the state to rely on budget cuts. Despite the presence of a rainy day fund and support at the state level to use these funds, some restrictions concerning such rainy day funds may make it difficult to quickly respond to a budgetary issue. Intergovernmental Aid Federal financial assistance helped many states avoid using more budget balancing strategies to close budget deficits during the 2008 economic recession. Many states indicated in their CAFRs that The American Recovery and Reinvestment Act (ARRA), which was signed into law by the federal government in February 2009 had helped them maintain many services in education, health, and transportation. Although federal funding for state governments increased in FY 2010 and FY 2011 respectively, the opposite happened in the funding from state governments to local governments. In a response to increased financial stress due to revenue losses and expenditure increases, funding for local aid was cut by states in FY 2010 (table 1). Compared to the $62 billion in Recovery Act Funds in FY 2010, federal fiscal assistance was significantly reduced to only $7 billion in

9 34 SHI FY This substantial reduction strongly affected state budgets. As a direct consequence, some states had sequential state aid reductions throughout economic recession. Revenue Increasing Strategies States reacted quickly to increase revenues after budget deficits worsened their fiscal conditions by increasing major tax sources such as sales tax, income tax and various fees, rather than relying too much on cigarette tax, alcohol tax and motel fuel tax during and after the Great Recession of Table 2 shows the number of states that adjusted their taxes and fees to increase revenues. It is clear that the number of states taking tax-related actions to increase revenues is positively correlated with the severity of budget shortfalls. For FY 2010 in particular, 12 states enacted sales tax increases, 18 states enacted income tax increases, and 21 states enacted cigarette, tobacco and alcohol tax increases, and 19 states enacted fee increase actions. The increase in the number of states taking tax revenue action in FY 2009 to FY 2010 is a further indication of the extent and severity of revenue deficits and of the fiscal deterioration across states (Table 2). Figure 1 also suggests that the percentage of revenue actions increased in FY 2009 to FY This tendency implies that states were quite active in taking revenue increasing TABLE 2 Number of States Which Enacted Revenue Increasing Actions Fiscal Years Sales Tax Personal Income Tax Corporate Income Tax Cigarette, Tabaco and Alcohol Taxes Motor Fuel Tax Other Taxes Fees Data source: NABSO.

10 STATE BUDGET SHORTFALLS AND BUDGET BALANCING STRATEGIES 35 actions to alleviate the negative impact of budget shortfalls on their fiscal conditions and to generate additional revenues to offset revenue declines. Facing revenue declines during the economic recession, states increased actions on major taxes such as general sales tax and income tax, rather than focusing on cigarette and tobacco taxes, alcohol taxes, or motor fuel taxes. Revenue actions related to these major taxes, which have a broad tax base, are more likely to generate additional revenues than selective sales tax and other minor taxes. For example, Indiana increased its sales tax rate from 6% to 7%, which resulted in a revenue increase of $898.9 million in FY In FY 2010, rate increases for personal income tax in California and New York increased revenue collections by $4.3 billion and $4.1 billion, respectively. New York increased its cigarette tax from $1.50 to $2.25 per pack, which increased its revenues to $265 million in FY Higher alcohol tax rates in North Carolina raised its revenues to $35.6 million in FY 2010, whereas Tennessee s tax on Health Maintenance Organizations raised its revenues to $137 million. In addition, some states introduced gambling and lottery taxes. South Dakota imposed an additional gaming tax of 1% on Deadwood casinos, and thus raised its revenues by $1 million 2. This paper s results on state tax revenue policies seem to be consistent with the arguments of Dye and McGuire (1999) and Merriman (2000), namely that states often implement tax revenue policies to generate additional revenue and offset revenue declines during difficult economic times. However, this result differs markedly from the findings of Magg and Merriman (2007) for the 2001 economic recession in which states used savings to ensure economic difficulties without severe budget cuts or substantial tax increases. Expenditure Reducing Strategies Due to heavy pressures on more declines in revenue collections and increasing expenditure demands, some states were unable to meet previously set revenue collections forecasts and were forced to make mid-year budget cuts during this economic recession to comply with budget balance requirements. In FY 2008, only 13 states cut budgets. Nevertheless, 41 states and 39 states made mid-year budget cuts in FY 2009 and FY 2010 (Figure 2). This exemplifies the fiscal difficulties for state governments during these two fiscal years.

11 Amount of budget cuts ($) 36 SHI FIGURE 2 Mid-Year State Budget Cuts, FY2008-FY ,000 30,000 25,000 20,000 15,000 10,000 5, For those states that did implement budget cuts, K-12 and higher education programs, Medicaid, and correctional facilities were severely affected. However, K-12 and higher education were particularly most severely affected. According to the NABSO report on FY 2010, 35 states cut K-12 education programs and 32 states cut funding for higher education programs. Cuts made in FY 2011 were consistent with those in FY As a result of these budget cut, increasing fiscal challenges were imposed on public education programs and states had to take measures to cope with this. For example, states such as Florida and New York increased the tuition for their public universities (Johnson et al, 2010; Knutson, 2010). Together with revenue actions, states performed expenditure-side budget balancing to address deteriorating fiscal conditions. For fiscal years 2009, 2010 and 2011, the most common state expenditure cutting strategies are targeted cuts, across-the-board cuts 3 and local aid reductions (table 1). Taking fiscal year 2010 as an example, to address budget shortfalls approximately two-thirds of states undertook targeted cuts, nearly half employed across-the-board cuts and approximately 20 states reduced local financial aid.

12 STATE BUDGET SHORTFALLS AND BUDGET BALANCING STRATEGIES 37 States also developed personnel strategies to reduce expenditures. Layoffs and furloughs were two common strategies used by states during this economic recession; for example, 25 states introduced layoffs and 22 states instituted furloughs to eliminate budget shortfalls in FY In table 1 it is clear that these personnel strategies were significantly less popular in FYs 2012 and CASE STUDY OF THREE STATES To provide more detail in the discussion of state budget shortfalls and state budget balancing strategies, this paper presents case studies of three states: New York, Texas and Washington. Even though they are located in different parts of the US, all three states were affected by the Great Recession of 2008 and observed similar downturns in economic growth. Consequently, all three states had to cope with the problem of budget shortfalls. The paper compares their budget balancing strategies to eliminate budget shortfalls. This comparison can help us better understand why New York was able to considerably reduce its budget deficit but Washington and Texas were unable to during FY 2009 to FY 2013 (Table 3). The textual materials in these states CAFRs from FY 2009 to FY 2013 serve as the major source for this analysis with regards to the links between budget TABLE 3 The Dollar Amount and Percentage of Budget deficits for New York, Texas and Washington for Fiscal Years FY 2009 FY 2010 FY 2011 FY 2012 FY 2013 State $ % $ % $ % $ % $ % New York Texas NA NA Washington Source: Center on Budget and Policy Priorities and National Association of State Budget Officers. Note: Dollars in Billions of US Dollars. % of budget deficits is measured by the total amount of budget deficits as a percentage of general fund expenditure. NA means Not Available.

13 38 SHI balancing strategies and the impact of these measures on revenue collections and budget shortfalls. Three states have different performances in reducing budget shortfalls. New York performed exceptionally in managing to reduce its budget deficits from more than $21 billion in budget shortfalls in FY 2010 to approximately $2 billion in FY Texas is the only state among 50 states that was unable to reduce its budget shortfalls. Its budget shortfall eventually totaled $9 billion, which accounted for 24% of its general fund expenditures in FY Washington reduced some of its budget shortfalls, but its budget deficits still made up 24% of general fund expenditures in FY New York New York State amassed $21 billion in budget shortfalls in FY 2010 after its economy was severely affected by the nation-wide financial crisis. The budget shortfall was due to a decline in revenue collections. At the beginning of the economic recession, New York State faced dramatic declines in revenues from a variety of tax sources such as personal income tax, consumption and use tax, business tax and other taxes due to declining financial markets, declining corporate profits, deteriorating real estate markets and a further deepening of the recession. New York State s budget shortfalls were brought into balance with various increases in taxes and fees, expenditure cutting strategies and federal aid from the American Recovery and Reinvestment Act (ARRA). Approximately $8 billion of budget shortfalls were offset by the federal stimulus bill, also known as ARRA, which provided budgetary relief to most states and helped these state avoid more significant cuts in budgets and services. Various forms of temporary or permanent tax revenue-increasing strategies were used to increase revenues, primarily through sales tax and income tax (Table 4). These significant initiatives reduced the total amount of budget shortfalls by roughly half. Because personal income tax was the major tax revenue source for the state, one strategy was to temporarily increase the income tax rare for people with a high income. The increase in personal income tax revenue in FY 2010 was also due to the elimination of the School Tax Relief (STAR) rebate program for the middle class and an increase in

14 Fiscal Years Sales tax Income tax Other taxes Fees Budget cuts Targeted cuts Across the broad cuts Local aids reductions Early retirement Layoffs Reorganization STATE BUDGET SHORTFALLS AND BUDGET BALANCING STRATEGIES 39 TABLE 4 Budget Balancing Strategies in New York State, FY 2009-FY X X X X X X X 2010 X X X X X X X 2011 X X X X X X X X 2012 X X X 2013 X X X Source: NABSO fiscal survey reports and CAFRs. withheld and estimated tax payments from the same period last year. In addition to the income tax, New York State introduced successive increases in selective sales taxes increase such as for the cigarette tax and tobacco tax. In FY 2010, other taxes such as auto rental tax were increased and various fees were introduced to collect more revenue. Due to strong efforts to increase revenues using all types of taxes and fees, New York was able to maintain stable tax revenues and total revenues throughout the economic recession (Table 5). TABLE 5 Revenues in Governmental Funds of New York State (In Millions of Constant Dollars) Fiscal Years Total Revenue 110, , , , ,449 Total Tax Collections 56,480 56,375 58,704 59,062 61,995 Personal Income 33,096 33,623 35,597 35,531 38,365 Sales and Use 10,906 10,422 10,837 10,967 10,948 Cigarette Tax 1,330 1,352 1,518 1,508 1,416 Federal Grants 41,637 50,049 51,603 44,481 45,040 Source: State CAFRs, FY2009-FY2013.

15 40 SHI The state took a balanced approach to eliminate budget shortfalls for both FY 2010 and FY Together with revenue increases from taxes and fees, the state adopted a number of expenditure reducing strategies, such as targeted cuts, across-the-board cuts and reductions in local aid (Table 4). In FY 2009, for example, the fiscal impact on local governments was more than $3 billion due to local aid reductions. Local education programs and human services were greatly affected by the financial cuts undertaken by the state government. Since FY 2012, the state s expenditure cuts have focused on personnel-related measures such as layoffs and early retirement as well as policy measures to reduce expenditures. Texas The budget balancing strategies employed by Texas can be characterized as a myth. Fiscal survey reports by NASBO gave little indication of specific budget balancing strategies for Texas. The reports show that Texas imposed a $5 fee on customers of sexually oriented businesses in FY 2009, changed the way smokeless tobacco is taxed in FY 2010 and introduced targeted cuts in FY 2012 to balance the budget. Rather, the CAFR of FY 2011 says that the state s major initiatives was focused on short-term measures to close successive budget shortfalls and that state policy makers would provide an effective and long-term financing plan to address this pattern 4. Information from CAFRs and NABSO reports on rainy day funds indicates that Texas did not use its economic stabilization fund 5 as a cushion for budget shortfalls. It is also surprising to find that Texas had the largest rainy day fund of the fifty states (Figure 3). The total amount of available reserves in Texas was much higher than that of Washington State which depleted its state savings during the recession. According to Texas s CAFRs, use of the economic stabilization fund requires a two-thirds majority vote in the legislature. Despite the presence of such a large size of rainy day fund, Texas could not use this fund without permission from its legislature. This example demonstrates that legal authorization can be an influential factor limiting the use of rainy day funds. Under these circumstances, what strategies were chosen by Texas? State CAFRs provide us with some insights. First, Texas

16 Constant dollars in millions STATE BUDGET SHORTFALLS AND BUDGET BALANCING STRATEGIES 41 FIGURE 3 Budget Stabilization Fund $8,000 $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $ Texas New York Washington received substantial federal financial assistance. In FY 2009, the state suffered from the largest tax revenue loss as a result of reductions in natural gas and oil production, and hence, total tax collections. Over $35 billion in federal aid helped offset the revenue loss, and this amount accounted for nearly 25% of Texas s total revenues in governmental funds for FY However, federal financial assistance is only temporary. When federal funds lessened and even stopped altogether, Texas total revenues declined again and the state continued facing budget deficits. Second, Texas relied on successive budget cuts to reduce expenditures from FY 2009 to FY For example, a total of $813.2 million in budget cuts was implemented for debt service programs, Medicaid entitlements, social security contributions and financial aid for higher education. Additionally, FY 2011 CAFR stated that to stay in black, Texas had cut spending across the board. This further indicates that expenditure-side strategies were employed as the main measure to maintain balanced budgets in Texas. However, table 3 shows the budget deficits trend in Texas from FY 2009 to FY The example of Texas indicates that relying too much on

17 42 SHI budget cuts and federal funding may not be very effective to help states reduce or eliminate budget shortfalls during an economic recession. Washington Similar to Texas and New York, Washington benefited from federal financial assistance. In FY 2009, more than $2 billion in federal stabilization funds was transferred to Washington, which helped the state avoid significant service cuts in the sectors of education, public health and transportation. Washington has the similar legal requirements if the state governments needed to use rainy day fund during the period of financial difficulties. For example, the use of rainy day fund requires the vote of at least three-fifths of the members of each house of the legislature. Unlike Texas in which the use of such reserves was not approved by the legislature, cash was transferred to rainy day fund in accordance with provisions in the state s Constitution. Compared to the revenue actions taken by New York State, only a few revenue increasing strategies were adopted by Washington. Most of these were adopted in FY 2011, such as, for example, a tax on the sale of bottled water, sales taxes on candy and gum, and a cigarette tax. Although sales and use taxes are the main sources of revenue for the state s government, its taxable sales base was affected by the reduction in consumer spending as a result of job losses and weak consumer confidence. In FY 2011, the state increased its tax rate on business and occupation, which is the second largest source of tax revenue and can be used by the state government to generate additional revenues. However, these revenue measures only partially offset tax revenue losses that resulted from the economic downturn and the housing market slump. As shown in Table 6, Washington employed more expenditurereducing strategies including budget cuts, targeted cuts and personnel measures than revenue actions to alleviate budget shortfalls during and after the economic recession of Compared to the expenditure-side measures taken by New York, Washington adopted more personnel measures such as furloughs and benefit cuts to lower its expenditures. However, Washington s focus on expenditure-cutting strategies and its decision to use the

18 Fiscal Years Rainy day fund Sales tax Other taxes Fees Budget cuts Targeted cuts Across the broad cuts Local aids reductions Employee benefit cuts Layoffs Furloughs STATE BUDGET SHORTFALLS AND BUDGET BALANCING STRATEGIES 43 TABLE 6 State Budget Balancing Strategies Taken by Washington, Fiscal Years 2009-FY X X X X X 2010 X X X X X X X 2011 X X X X X X X X 2012 X X X X X 2013 X Source: NABSO fiscal survey reports. rainy day fund to close the budget shortfalls have been less effective than the strategies taken by New York, which significantly reduced its budget shortfalls during the same period. DISCUSSION AND CONCLUSION This paper investigates the impact of state budget shortfalls with a specific focus on their states choices of budget balancing strategies associated with the Great Recession of Based on the study of 50 states, this paper categorizes budget balancing strategies into several types and discusses them using the textual data from NABSO reports and CAFRs. For example, the mere existence of a rainy day fund did not necessarily allow states to avoid using revenue increasing or expenditure cutting strategies. During the economic recession of 2008, states used substantial revenue enhancement strategies and severe expenditure cutting strategies to endure economic difficulties and cover budget shortfalls. Most states were beneficiaries of federal financial aids, which became available after ARRA in Substantial federal funding helped states avoid making significant service cuts and other personnel measures such as layoffs.

19 44 SHI In addition to the general view across all fifty states, the paper also compares the patterns of budget balancing strategies used in three different states to address their budget shortfalls and achieve different outcomes from FY 2009 to FY All of three states benefited from the federal funds (ARRA) during the recessionary periods. However, the review of budget balancing strategies for these states suggests that distinctions exist in use of budget balancing strategies. Results from the case analysis show that state adopted strategies with different focuses such as either revenue enhancements or expenditure reductions would result in different outcomes. Among these three states, New York was more successful than the others in reducing budget shortfalls. The review of New York State s budget balancing strategies during and after the economic recession indicates that the state applied a balanced approach that placed equal importance into revenue increasing measures and expenditure cutting strategies to stave off the most severe budget shortfalls in FY 2010 and FY In other fiscal years, New York took more revenue actions to improve revenue collections and cover budget deficits. Using such strategies, New York State was able to keep its revenue collections stable over time and significantly reduce its budget shortfalls in FY Washington reduced part of its budget shortfalls, and Texas was the only state that had higher levels of budget shortfall during and after the Great Recession of Examination of Washington State s budget balancing strategies and budget shortfalls indicates that fast balancing strategies, such as budget cuts, drawing on rainy day funds, targeted cuts and various personnel measures, were most frequently adopted as the recession lingered. Texas mostly applied budget cuts and across-the-board cuts to reduce spending, and relied on federal aid to cover revenue shortfalls. For both states, less frequent strategies were related to revenue enhancement. Unlike New York, both Washington and Texas would continue to face fiscal problems in balancing revenues with expenditures once federal funding no longer was available. In the face of the economic downturn, most states would employ budget balancing strategies to cope with budget shortfalls. Previous studies have found that states were far less reliant on tax increases during the economic recession of 2002 (Magg and Merriman, 2003).

20 STATE BUDGET SHORTFALLS AND BUDGET BALANCING STRATEGIES 45 However, the case studies in this paper suggest that states had different considerations and barriers in choosing between strategies once they had been severely impacted by the economic recession. By being aware of the existence of such distinctions in the strategic choices of different states, governmental officials and policy makers can learn lessons from such diverse experiences and more effectively support their own strategic choices in fighting budget shortfalls. Looking forward, the next step is to assess how states responded differently after federal aid was no longer available and to assess what the long-term financial impact is of adopting revenue increasing strategies and expenditure decreasing strategies on states fiscal conditions in the years following the Great Recession of Undoubtedly, federal aid played an important role in alleviating state budget shortfalls. It is interesting to discover more about how state and local governments reacted to the reduction of federal aid. Additionally, we are already seeing that states varied with regards to budget balancing strategies. Some states prefer using revenue enhancement while others emphasize expenditure side strategies to cover budget shortfalls. Would states that focus more on revenue actions encounter more fiscal issues than states that focus on expenditure cutting strategies in the long-term perspective? Do policies that apply more severe expenditure cutting strategies have a more severe impact on the public in the long-term because expenditure cuts result in reduced services and layoffs? These are all interesting questions to explore in the future research. NOTES 1. Data are collected from reports published by the Center on Budget and Policy Priorities (CBPP). 2. Information is collected from Fiscal Survey reports published by the National Association of State Budget Officers (NABSO) for fiscal year of Across-the-board cuts represent a fixed percentage cut imposed on all or most state agencies, whereas targeted cuts were defined by NASBO as cuts to state employee pay raises, eliminate or reduce funding for low priority programs or high priority programs.

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