States' fiscal picture brightens; Medicaid problem still looms

The latest fiscal report released by the National Governors Association (NGA) and the National Association of State Budget Officers (NASBO) said state revenues improved in 2005, enabling many states to begin restoring funding to programs that had been cut during the economic downturn. But the 2005 year-end report cautioned that the budgetary strain imposed by Medicaid and issues such as pensions, growing school-age population, and infrastructure needs are causing some states concern about the long-term outlook.

"The data demonstrate a positive trend in the fiscal condition of our states," commented NGA executive director Raymond Scheppach. "Following a long period of fiscal downturn, states are climbing their way back to economic health."

Surpassing expectations

In every state, according to The Fiscal Survey of the States, FY 2005 collections of sales, personal income, and corporate income taxes either met or surpassed budgeted estimates. Also, FY 2005 revenue collections were 4% higher than anticipated in originally enacted budgets. Sales taxes were 1.2% higher, personal income taxes were 5.7% higher, and corporate income taxes were 11.6% above original estimates.

Mr. Scheppach said another encouraging sign is that states are restoring normal levels of total balances. Composed of ending balances and the amounts in budget stabilization funds, total balances were a critical tool for combating the recent fiscal downturn and a bellwether of states' fiscal health, he said. Strong state revenues have allowed states to begin to rebuild budget reserves to levels at or above those considered adequate by budget observers (roughly 5% of expenditures). In FY 2005, total balances were $38.5 billion (6.8% of expenditures), up from $26.7 billion or 5% of expenditures in FY 2004. However, total balances are expected to decline in FY 2006 to 4.6% of expenditures.

By comparison, prior to the last economic downturn, in FY 2000 total balances were $48.8 billion or 10.4% of expenditures.

Although the revenue side of the equation appears to be improving, pressures on the expenditure side continue to make officials nervous. "States still face growing health care costs, an aging population, infrastructure needs, high corrections costs, and in many cases underfunded pension systems," said NASBO executive director Scott Pattison.

Health care biggest fiscal worry

Survey results indicated that health care funding, and particularly Medicaid funding, is the single biggest obstacle to states' positive fiscal outlooks. According to recent figures from the Kaiser Commission on Medicaid and the Uninsured, Medicaid spending increased by 7.5% in FY 2005. Even with extensive cost containment and one-time federal fiscal assistance, Medicaid expenditures have exceeded the amount that many states originally budgeted for the program. Some 22 states experienced Medical shortfalls in FY 2004, with the shortfalls ranging between 0.2% and 11% of program costs. And 26 states anticipated shortfalls in FY 2005.

The report noted that Medicaid expenditures are approximately 22% of all state spending, with overall spending on health care constituting some 32% of state spending.

More money from state

While Medicaid spending increased by 7.5% in FY 2005, states appropriated an increase of 5.5% for Medicaid in their FY 2006 budgets.

"Based on governors' recommended budgets," the report said, "the increase in state funds will most likely be larger than the increase in federal funds. The higher growth rates of state funds vs. federal funds are attributable to factors such as a change in the amount of federal funds individuals states will receive as part of the FMAP formula in current law and the phase-out of the one-time federal special relief."

NGA said the combined amount of FY 2004 and FY 2005 Medicaid shortfalls was more than $5.9 billion. Every state implemented some measure to control Medicaid spending in FY 2005, such as including supplemental funding and implementing additional cost containment measures.

The analysis said enrollment increases have played a major role in the higher Medicaid spending, with enrollment increases of 4% in FY 2005, based on the Kaiser Commission survey.

"While children and families are often the group contributing most to the enrollment change, the elderly and disabled are usually the group contributing most to the increased costs from enrollment changes," the report said. "The average cost per recipient varies greatly in Medicaid with the elderly and the disabled costing about seven times the amount per recipient as children and adults."

Care costs exceed projections

With long-range projections of Medicaid growth running at 8% to 9%, states are concerned that health care cost increases exceed their revenue growth. States also are concerned about the rising number of uninsured and the impact on public programs, including Medicaid. Demographic pressures and the costs of providing long-term care also have been cited as significant issues facing states.

Adding to state unease is confusion over the impact of the new Medicare Part D prescription drug benefit on Medicaid programs, potential federal changes to Medicaid, and the Medicaid waiver process, according to the NGA report. Also concerning state officials are employee health insurance, unfunded liabilities in state retiree benefit programs, and staff shortages in medical personnel, enrollment increases, and cost of and access to mental health services.

Strength of taxes

The revenue and spending assessments by the nation's governors and state budget officers were echoed by state legislators. A budget update from the National Conference of State Legislatures (NCSL) said revenue collections were above forecasted levels in 42 states, on target in six states, and below projections only in Rhode Island.

Personal and corporate income taxes were strong in most states, according to NCSL, and five states noted high estate tax revenue. Seven states reported below-forecast state sales tax collections through the first quarter of the fiscal year.

On the spending side, NCSL said, unfunded federal mandates continue to hamstring states. The association identified $51 billion worth in FY 2004 and 2005, and the FY 2006 federal budget proposal included at least another $35 billion, depending on final budget reconciliation decisions.

Spending demands

"Since FY 2001, state legislators have closed an aggregate $263.8 billion gap," NCSL reported. "Now spending demands are coming from programs that have yet to be replenished, as well as rising new costs in areas such as health care, education, and energy assistance. Nineteen states reported spending overruns at the end of the first quarter of FY 2006, compared with 23 at this time last year. Medicaid is over budget in 12 states, corrections in seven, and education in three."

NCSL's survey asked legislative fiscal directors to name the top three fiscal issues lawmakers in their state would debate. Medicaid was ranked at the top of the list, with 23 states naming it as one of their top three. Education was put high on the list by 15 states, and taxes were up for discussion in 14 states.

"Every issue is really a fiscal issue," said NCSL executive director Bill Pound. "That's why when state economies suffer, state services follow suit. States have climbed out of their budget deficits, and now they're working on the service deficits."

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