New Jersey and many other states have been able to boost budget reserves during the long recovery from the Great Recession. But that doesn’t mean state budgets aren’t vulnerable to the next economic downturn — and perhaps New Jersey’s more than most because of its still relatively scant budget reserves.
A new analysis from The Pew Charitable Trusts raises several concerns for states as they get ready to face the next possible recession, including how a major downturn could impact already volatile revenue sources like the income tax, which is a major source of funding for New Jersey’s budget.
Meanwhile, a recent report by Fitch Ratings, a Wall Street credit-rating firm, suggested states could begin to lose out on federal funding if a recession triggers belt-tightening by the federal government. By contrast, New Jersey received millions in aid from the federal government in the aftermath of the 2007-2009 Great Recession, initially helping it avoid major cuts to things like K-12 school aid.
The risk could also extend down to local governments, Fitch warned, since they rely on funding from federal and state budgets as well.
“To maintain (credit) ratings, state and local governments would need to demonstrate their ability to manage through a federal deficit reduction in a manner that retains an appropriate level of financial flexibility,” the Fitch report said.
One way that states prepare for a recession or some other unexpected drop in revenues is by maintaining robust budget reserves that can be used instead of making program cuts or hiking taxes to make up the gap. New Jersey’s budget reserves are primarily kept in two funds — the unrestricted Fund Balance, which is more commonly referred to as the “surplus,” and the restricted Surplus Revenue Fund, which is more commonly referred to as the “rainy-day” fund.
The state’s reserves were boosted to $1.276 billion in the budget for fiscal year 2020 that Gov. Phil Murphy signed into law in late June. Included in that total was a $401 million deposit into the rainy-day fund, which was the state’s first since the fund was completely depleted during the Great Recession.
Yet even with the overall increase, New Jersey’s budget reserves remain at the low end when compared to other states. The 50-state median for budget reserves in FY2019 was 7.5% of annual spending, according to data collected by the National Association of State Budget Officers. But for New Jersey’s $38.7 billion budget for FY2020, the reserves equal 3.4% of total spending.
The Pew analysis, released earlier this month, also notes that recessions often strain state resources and can bring on spending cuts that impact programs and employee levels. In many states, spending on things like higher education and infrastructure have still not recovered from the Great Recession, meaning the next round of cuts would likely hit other areas. State employee numbers also remain low across the nation even as the economic expansion has progressed.
Pressure on state governments
“With state governments leaner in this respect, further cuts during the next recession could hamper their operations significantly,” the Pew analysis said.
Returning to the issue of volatility, Pew also highlighted that sources of revenue gains for many states since the end of the Great Recession have been in areas like investment interest, stock dividends and capital gains, all of which are heavily influenced by the overall health of the economy.
“These sources are notably subject to big swings in the stock market, which can often occur during periods of economic distress,” the Pew analysis said. “Because state revenue growth relies on more volatile sources, policymakers may need to plan for steeper declines by accruing more reserves.”
Medcaid is a concern
Among the federal spending that could be at risk during a downturn is on the Medicaid program, according to the Fitch report, which was released late last month. Yet demand for Medicaid services often picks up during an economic downturn as more people face difficult personal circumstances, and that in turn could put more pressure on states to make up any gaps.
“Even though Medicaid is a mandatory congressional appropriation, meaningful changes to its funding structure cannot be ruled out over the long term, which could reduce overall federal Medicaid funding and raise fiscal burdens on states that choose to offset federal declines,” the Fitch report said.
Another lingering concern, according to Fitch, is the federal government’s own debt and deficit, which have increased during President Donald Trump’s tenure despite the long run of generally positive economic conditions.
“The effect of longer-term federal deficit reduction on state and local government ratings would depend on the extent of the cuts, the types of functions targeted and the flexibility Fitch expects specific governments to have to counteract federal action,” the Fitch report said.