New Jersey Faces Long-Range Fiscal Challenges
Editor's Note: The Winter 2010 issue of Legally Speaking contained an article entitled "New Jersey's Budget Squeeze: What It All Means," by David Nash, Esq. That article focused on how state law impacts school district finances. How does the state's school budget fit into the overall state budget? Richard Keevey of Rutgers addresses that question in this article.
New Jersey has serious budget problems. I know from personal experience that the state will have a difficult time managing its finances in the coming years. I do not know how the state's fiscal house will ultimately be mended, but I am quite certain there will be large-scale changes. The gap between revenues and program needs continues to grow - and no easy solution is discernable.
The budget is in balance for the 2010-11 fiscal year, but it was achieved by making $10.8 billion in reductions to current service requirements, and by skipping a $3.1 billion pension contribution. Governor Chris Christie and the Legislature made difficult but needed decisions.
Although a good start, the current budget has not solved the problem - much more needs to be done. Projections for the foreseeable future suggest that because of the structural deficit that was created during the mid-1990's and never properly addressed, the problems still exist.
Furthermore, budgetary challenges are not confined to the state government. There is, in fact, a complex interdependency between state policy decisions, court rulings, and the impact of spending at the local levels of government.
If the state, for example, reduces state aid for schools or municipalities, it has an impact on the budgets of these entities. Furthermore, if property taxes are increased at the local level, property owners throughout the state feel the impact just as if the state government raised taxes.
Moreover, at this very moment the New Jersey Supreme Court is hearing a case that is challenging the state's reductions in school aid in the current year's budget. A successful challenge in the case will further exacerbate the gap between revenues and spending. It is clear that the interdependency between all government levels suggests that not only are we confronted with a state budget challenge, but an entire state-wide challenge.
Here is what needs to be done in New Jersey:
- Bring long-term spending commitments into line with the revenue base
- Change the funding structure for retirement benefits
- Gain control over school aid formulae, and other mandates, and contractual obligations
- Deliberate carefully about any reductions to safety net programs
- Address the total state enterprise - state and local governments, including schools
- Improve the business climate while maintaining needed resources
Composition of Spending
It helps to consider some basic information:
Unlike the federal budget, which is invariably in deficit-with no solutions except borrowing-the State of New Jersey is required to have a balanced budget without borrowing for operations.
The composition of the current $28.4 billion state budget (there is an additional $14 billion in federal dollars available for designated programs) is such that the majority of the expenditures assists organizations outside of state government:
- Seventy-three percent of the budget consists of state aid payments to municipalities, counties and school districts, as well as grants-in-aid to non-government entities and individuals for such items as Medicaid, homestead rebates, hospital assistance, and universities, including student assistance.
- Seven percent services debt on bonds previously issued for transportation, environmental needs, etc.
- Only 20%, or $6 billion, is spent for state government operations.
An even more important issue that is not quite evident in the overall budget numbers is the underfunding of employee retirement systems. Specifically, unlike other state programs, the retirement program costs have extensive and very serious long-term liabilities that need to be addressed. Consider these facts:
- unded liability of state pension systems, including the teacher pension system is $37 billion, making the pension system less than 56% funded;
- the unfunded liability for post-retirement medical benefits is $57 billion, of which $32 billion is for retired teachers and other school board employees. No future year costs have been funded;
- thus, the total unfunded liability for state government-responsible retirement costs is $94 billion;
- a similar problem exists at the municipal and county levels of government where the unfunded liability is almost $17 billion (70% funded), and $10 billion for retirement medical costs. There is an additional health benefits liability for other jurisdictions that do not participate in the state system.
The Major Challenges
The fiscal problems facing the state can be addressed by focusing on these six major issues:
Spending commitments are far greater than the revenue base
Sixty-two percent of all revenues come from the income and sales tax. During the current recession, the income tax decreased from $12.6 billion in FY 2008 to $9.8 billion in FY 2011. But spending demands cannot decrease in the same proportion, as existing formulae for schools, retirement benefits, and case-driven Medicaid requirements -just to name three-continue to increase rapidly. On a projected basis these expenditures far exceed the revenue structure.
The state has unfunded liabilities in excess of $94 billion for promised retirement benefits.
The state pays the employer's share of pension and retirement health benefits for state and school district employees. The budget for health benefits alone is $1.3 billion. No monies were provided for required pension obligations, either in the current budget, or for most of the preceding 15 years.
Governor Christie recently signed legislation that reduces pension commitments to 1/7 of the required amount for next year, with progressive increases in the following years. But this change does not solve the problem.
So, the Governor has proposed nine major pension changes, including raising the retirement age and increasing employee contributions. Such changes would fund the pension systems at a 90% level over the next 30 years.
Similar long-range changes have been proposed to address health benefit costs, including increasing employee contributions to 30% of the cost of the insurance premium.
Retirement pensions and health benefits are the greatest albatross surrounding the state's finances. Time is critical. Without immediate action, the pension funds, for example, will soon be empty.
The Governor and the Legislature have little control over large budget items because of mandates, contractual and constitutional obligations, and federal requirements.
Using school aid as an example, the New Jersey Supreme Court has ruled the state has a constitutional obligation to fund schools at certain levels, especially for the poorest districts. Given the existing formulae, it is estimated that $13.5 billion is needed by the year 2015 - almost 40 percent more money than is now raised from the income tax. In the current year, the Governor halted school aid increases, and most likely this &rldquo; "spending pause"” will continue. The underlying school formulas, and other requirements/mandates, need to be re-examined so requirements can be matched with revenues.
But, as previously noted, the Supreme Court has just ordered a hearing on the constitutionality of recent reductions in education funding that could change the pattern of school spending.
Reduce social programs, particularly Medicaid, with careful deliberation.
Social programs provide the necessary safety nets to protect our most vulnerable. Funding them presents a moral dilemma for decision makers as reductions will likely be necessary, particularly in the Medicaid program. Approximately $4 billion in state dollars are expended for Medicaid on a wide variety of health-directed programs for the poor and elderly, and aside from school aid, Medicaid is the largest single appropriation in the budget-and is the state's fastest growing program. Reductions will most likely be necessary in program content and eligibility, but they need to be carefully considered as they affect our most needy population.
Control local spending practices.
Spending policies at the local level must be addressed. Consider, for example, that the local property tax is $24 billion statewide, which is 20% more than the state collects from income, sales and corporation taxes. Furthermore, all state income taxes are returned as aid to local governments, principally school districts.
The Governor and Legislature have taken steps to limit local property tax increases to 2%. In addition, limits have been placed on arbitration settlements for public employees. These kinds of adjustments were necessary if the state and its local jurisdictions are to address rising property tax burdens throughout the state.
The state is a high-cost place to do business and a review of the tax structure is warranted.
It is very difficult to gain consensus on the ideal tax structure at the state or local level, or on which business incentives will bring about the greatest return to foster economic development and expansion. These elements need to be analyzed carefully so legislation is crafted to expand business, and provide the necessary resources so the state can re-emerge as a good place to do business, and live.
Concluding Comments
Several cost drivers were necessarily reduced by the Governor in the current year, but the major constraint on spending remains the availability of revenue. Thus, it is not practical to approach future budgets singularly from a current service needs projection. Instead, the budget should be developed within revenue constraints.
Every constituent group will claim that its services are critical. Consider, for example, the recent outcries from the arts community, teachers, municipalities, and transit riders when the current budget was implemented - and, one might argue, these groups are not our most needy.
We need to reflect on whether we have a tax structure that is fair to individuals, business and homeowners. If not, how might we change it? The state might consider rationalizing the tax structure to reflect changes in the economy. For example, the state could broaden the sales and corporation tax base, but decrease the rate, review property tax exclusions and deductions, and deal with the growth of internet sales and services.
On the spending side, serious thought needs to be given to prison policy; rising health insurance costs; personnel and management changes; government and state-wide reorganizations, consolidations and the sharing of services. Furthermore, careful thought needs to be given to determine what our most pressing priorities are, and what types and levels of services are necessary to meet these priorities. In the past, these and other actions might have been considered too difficult to undertake - now they are critical.
But, these changes will not solve the structural imbalance. Hard choices are necessary. The national economy has had a large impact, but many years of bad fiscal practices have dealt this governor an unusually bad hand. No economic recovery or magic bullet will come close to solving the problem. We need dramatic, structural and immediate changes.
Richard F. Keevey is the Distinguished Practitioner in Residence at the School of Public Affairs and Administration, Rutgers University -Newark. Previously, he held appointments from two New Jersey governors as State Budget Director and Comptroller; and from the President as the Deputy Under Secretary of Defense for Finance and as the Chief Financial Officer for the U.S. Department of Housing and Urban Development.
A previous version of this commentary appeared in The Record of North Jersey.