Real Clear Markets

Is the Budget Coast Clear for State and Local Governments?

States and localities are often cast as the unsung heroes of American government: They spend more than the federal government on direct public goods and services, employ twice as many workers as the manufacturing sector, and generate about $1.8 trillion (12 percent) of GDP. But most people only really think about state and local governments when enrolling their kids in public school or visiting the DMV.

This narrative changed in the Great Recession and its aftermath. Casual observers became concerned about payroll and service cuts at state and local levels and what they meant for aggregate unemployment and growth. Although the federal government distributed unprecedented fiscal relief to states and localities through the Recovery Act, some have suggested it ought to do more.

The latest news is upbeat, however. Census Bureau figures (pdf) show state revenues are up for the ninth consecutive quarter, although growth is slower than last year and uneven across states. The National Conference of State Legislatures reports that no states are projecting deficits at the end of fiscal 2013 and many expect modest surpluses. The July jobs report suggests state and local job losses, although continuing, are abating.

So is the coast clear? Not yet. For one thing, local governments are still contending with lower property tax revenues as assessed values catch up with depressed home values.

The Great Recession was also when some reporters, analysts, and federal policymakers discovered state and local government debt, and became preoccupied with who was "the next Greece." Although nearly all state and local long-term debt goes to fund capital projects rather than operating shortfalls, states and localities do have significant unfunded liabilities for retiree pensions and health care benefits.

The watchword then, for states and localities just like the federal government, is "sustainability." Even after they emerge from the Great Recession and its aftermath, how do we ensure that states and localities continue to live within their means?

The answer is not obvious, especially given political pressures to the contrary. One thing that would certainly help is... better data. It may not sound exciting, but it's hard to know where the state and local sector is going if we don't know where it's been.

Consider the state and local component of GDP. A few weeks ago, the Bureau of Economic Analysis (pdf) reported that 2009 was not as bad as initially thought, but 2010 and 2011 were worse. Why? Apart from the usual noisiness of economic data, state and local government finances are hard to track. For one thing, there are a lot of them (89,476 as of the 2007 Census of Governments).

But more importantly, states in particular are sovereigns and don't have to accept external reporting requirements. States and localities do voluntarily participate in the gold standard Census of Governments conducted at five year intervals, as well as an annual survey for all states and a sample of localities. However, both data sources are available only after a significant 12-18 month lag, mainly because of delays in state and local government reporting.

What to do? One option is federal legislation. The Digital Accountability and Transparency (DATA) Act, which passed the House as H.R. 2146, would create a new federal grant oversight commission and require more state and local reporting, similar to the Recovery Act. However, with no additional funds attached, state and local groups are understandably concerned about compliance costs.

Another option is more voluntary disclosure, a tack suggested in a recent SEC report (pdf) on muni bond markets. However, as the SEC and an independent state budget task force have noted, there is wide variation in which governments make available and regularly update their audited financial statements.

It is worth recalling that states and localities were the birthplace of the Progressive Era budget accountability movement. They gave the federal government the idea of a modern executive budget. States and localities also have an interest in maintaining credit market access and keeping voters happy.

Thus, in the 21st century, they should reclaim the mantle of financial transparency, accountability, and open access, and they should run with it.