Seems like old times: State budget shortfalls worse than the early ’90s

New figures indicate the states are facing a budget crisis that is significantly worse than the recession of the early 1990s.

In mid-December, the National Governors Association (NGA) and National Association of State Budget Officers (NASBO) released data indicating that a combination of a dramatic fall in revenues, soaring health care costs, and increased homeland security costs in the wake of Sept. 11 have produced an overall state budget shortfall of $40 billion, with the possibility of it increasing to $50 billion as unemployment continues to grow.

Raymond Scheppach, NGA executive director, says 36 states faced shortfalls in December and that the overall impact already was worse than the recession of the early 1990s. He points out that the gross domestic product declined from the third quarter of 1990 through the first quarter of 1991, with unemployment increasing during that period from 5.4% to 6.8%.

But unemployment did not peak until June 1992, when it hit 7.8%. The states’ budget shortfall totaled $7.7 billion in 1990, $17.6 billion in 1991 (after 28 states had cut their budgets), and $19.5 billion in 1992, when seven more states were forced to cut their budgets.

"In terms of the three key measures — the number of budget cuts, the dollar amount of the shortfall, and the percentage of state revenues — this budget shortfall is more serious than it was during the recession of the early 90s," Mr. Scheppach says.

"If the shortfall goes as high as $50 billion, it will be 10% of state revenues, which is an unprecedented level," he explains.

Figures indicate that Medicaid costs are a major concern because they represent a high percentage of state expenditures, but could also be the source of a solution if the federal government would accept state requests for an increase in the federal share of Medicaid costs.

Medicaid spending a strain

According to NASBO’s Fiscal Survey of States, growth in Medicaid expenditures continues to strain state budgets across the nation.

The Congressional Budget Office (CBO) says Medicaid is projected to grow at an average annual rate of 8.3% from 2002 through 2010. This follows an 11% growth in 2001, 9% growth in 2000, and 6.7% growth in 1999, the year that Medicaid costs began to shoot up. The CBO says factors affecting program growth include the cost and use of medical services, especially prescription drugs. States also have seen sharp increases in enrollment of children as a result of successful outreach programs for Medicaid and the Children’s Health Insurance Program.

An October 2001 report from Washington, DC-based Kaiser Commission on Medicaid and the Uninsured indicates that the downturn in the economy coupled with the resurgence in Medicaid spending growth puts competing pressures on states. And those competing pressures are only likely to get worse as unemployment continues to grow in the months ahead, making still more people eligible for Medicaid.

Jocelyn Guyer, a senior policy analyst with Kaiser who wrote the Medicaid report, tells State Health Watch that a number of factors were responsible for holding down costs before 1999. First, health care inflation had subsided throughout the industry, in both the private and public sectors. Second, as a result of welfare reform, the number of people enrolled in Medicaid declined and the rate of enrollment growth slowed.

A third factor was that states learned to use creative financing techniques to get additional federal funds without having to provide Medicaid services. Such spending arrangements held real growth down in states but made real federal spending increase rapidly, she points out.

"But we’re now in a period of rapid health care inflation, and Medicaid enrollment is going back up, partly in response to the good work states have done in fixing enrollment problems," Ms. Guyer says.

A chart from the Kaiser Foundation report (see box, below) shows that state budget reserves grew from 5.8% of expenditures in fiscal year 1995 to 10.1% in fiscal year 2000. But in the second half of calendar year 2000, the slowing economy was felt in reductions of state revenue collections.

As a result, according to the Kaiser report, many states had to raid year-end balances to cope with budget pressures, leaving them in the current fiscal year with balances at a level only half of what they had just two years earlier.

Revenue drop = bleak outlook

And as NGA and NASBO have said, the outlook for 2002 is even bleaker because of a significant drop in state revenue growth.

Of particular concern to states is that future Medicaid spending growth is projected to outstrip relatively weak revenue growth, causing Medicaid to consume a larger share of state budgets over time. As a bar graph from the report shows (see top box, below), Medicaid rose rapidly as a share of state budgets between 1987 and 1995, but then remained relatively level in the mid-1990s. But as of the summer of 2001, states were projecting that their revenues would grow by only 2.4% during fiscal year 2002, even as Medicaid spending was expected to increase 8.7%. (See graph, below in bottom box.)

These projections seem to make it certain that Medicaid will once again grow as a share of state spending.

According to Ms. Guyer, an October survey of 20 state Medicaid directors and budget officials conducted for the Kaiser Commission found that more than half reported that in response to deteriorating fiscal conditions, they had been directed by their governors to prepare proposals to reduce current year (FY 2002) Medicaid spending below the level authorized by the legislature.

The pressure to reduce Medicaid spending could get worse because a significant number of states had made a decision to underfund their Medicaid programs in their FY 2002 budgets.

One wild card in the equation is the growing number of unemployed and their impact on the Medicaid program. Kaiser reports that the Urban Institute, also in Washington, DC, has used state-level unemployment and Medicaid enrollment data to estimate the impact rising unemployment rates might have on Medicaid enrollment absent any changes in state policy. And the picture does not bring comfort.

Swelling Medicaid rolls

The CBO has estimated that with a 4.5% unemployment rate, Medicaid enrollment would reach 44.7 million in 2002. However, with the unemployment rate rising from 4.5% to 5.5%, the Urban Institute projects that Medicaid enrollment will grow by another 1.6 billion, a 3.6% increase in enrollment. If unemployment went to 6.5% (still below the 7.8% peak in the 1990s’ recession), 3.2 million people would be added to Medicaid.

As higher levels of unemployment push Medicaid enrollment up, that increased enrollment means higher Medicaid spending. Thus, if the unemployment rate goes to 6.5% and an additional 3.2 million people are eligible for Medicaid, total state Medicaid spending would rise by $2.3 billion, an increase of 2.6% above spending already projected for 2002.

Unemployment also has an impact on the number of uninsured. An analysis conducted for Kaiser by Jonathan Gruber at the Massachusetts Institute of Technology in Cambridge shows that rising unemployment likely would lead to a substantial increase in the number of people uninsured. According to Gruber’s statistical model, every percentage point increase in the unemployment rate leads to an increase of some 860,000 uninsured.

Looking at that another way, for every 100 people who lose their jobs, the number of people uninsured grows by 85.

The model shows that as unemployment climbs, the number of people with employer-sponsored insurance falls, and the number of people with public coverage such as Medicaid rises, although not enough to fully cushion the impact of falling employer coverage.

If enrollment in public programs is not allowed to expand because, for example, of state budgetary problems, the effect of growing unemployment on the uninsured would be even greater.

Learning from the ’90s

In the recession of the 1990s, state actions fell generally into two categories, which may be instructive in terms of what states are likely to do now.

First, states worked hard to maximize federal funds coming in. It was during this period that states saw the first efforts at creative financing through payments to disproportionate share hospitals. Increased use of these arrangements enabled states to transform federal Medicaid matching funds into state general revenue dollars that were then used to shore up state spending on Medicaid or, in some cases, the entire state general fund budget.

The second state response was to make limited cutbacks on eligibility and services. Since much of Medicaid serves elderly and disabled people, as well as families with high medical costs, the Kaiser Commission report says it is likely that the effect of the changes was quite profound for the beneficiaries who lost coverage.

While there were cutbacks in eligibility and services, there also were expansions of Medicaid eligibility during the last recession.

This time around, much of the state effort through the NGA initially is being directed at bringing in more federal funds for Medicaid as part of the economic stimulus package. NGA says that only the federal government can assist the states because of states’ balanced budget requirements.

According to Mr. Scheppach, a temporary increase in the federal share of Medicaid costs would have several major advantages over other fixes. The most important benefit is that all $5.5 billion being sought would be spent during the current fiscal year, without need for any additional state legislation, and would help states cover three million to four million individuals, including 1 million children who are expected to become Medicaid-eligible.

Cutting is self-defeating

Kaiser says that if states respond to the worsening financial situation by cutting Medicaid in the months ahead, it could make it more difficult for newly unemployed workers and their families might have more difficulty in securing public coverage and could also reduce coverage for those currently enrolled in Medicaid.

Guyer’s report for Kaiser says that in recent years states have tried to slow the rate of growth in Medicaid expenditures without reducing eligibility for their programs and without cutting benefits directly. But continuing budget pressures may lead some states to look into such options. (See "Washington state's waiver request stirs fears that the public is losing accountability, review," in this issue.)

States have broad flexibility under federal law to establish the parameters of their Medicaid programs. They are required to extend eligibility to some mandatory groups, and face some minimum federal requirements with respect to benefits and cost-sharing. But they still have broad flexibility to determine the extent to which they will cover a number of optional populations and a significant degree of discretion to determine the amount, duration, and scope of benefits they will provide to enrollees.

Guyer says the challenge for states in the coming months will be to identify effective strategies for curbing Medicaid expenditures without compromising the care of Medicaid beneficiaries. States are likely, she says, to consider a broad array of strategies, including drawing on their reserve funds, making new efforts to control prescription drug costs, using tobacco settlement funds to support Medicaid spending, working with the federal government to increase its investment in Medicaid, taking steps to strengthen state revenue streams, and identifying strategies to contain costs.

Reducing Medicaid spending could be counterproductive in terms of the nation’s economic recovery since health care represents nearly 14% of the nation’s economy and any drop in coverage would mean reduced spending in the health sector, contributing to the ongoing economic tightening and partially offsetting economic stimulus activities.

"Maintaining coverage as we face this economic downturn is important not only for workers and their families, but also for reviving our ailing economy," Kaiser says. "Policy-makers need to consider the impact of the recession on states and their ability to support Medicaid whose costs are likely to increase in an economic downturn."

[Contact Ms. Guyer at (202) 347-5270, the National Governors Association at (202) 624-5300, and the National Association of State Budget Officers at (202) 624-7745.]