State finances are still rickety

This should be a big issue in state legislative races, but won't be.

Republican legislators and Democratic Gov. Katie Hobbs have grossly mismanaged state finances during the last two years of divided government.

In the first year, they went on a fiscally reckless spending spree. In the second, they attempted a modest retrenchment. 

So, where is the state now? Is the state fisc on a solid and sustainable footing? Far from it.

In fact, state finances are rickety, and more so than the official budget projections are showing. 

Control of the Arizona Legislature is up for grabs this election, with Democrats having a realistic shot at taking over one or both chambers. The rickety condition of the state fisc should be one of the most important issues discussed this election season, up there with housing and water. My guess, however, is that it will rarely get mentioned. 

The state entered Fiscal Year 2024, which ended in June, with a carryforward surplus from previous years in excess of $2.5 billion. 

According to the left, what caused the subsequent deficit was the 2.5% flat income tax and universal education vouchers. However, individual income tax collections in 2024 were $394 million less than in 2023. The cost of the expanded voucher cohort was in the vicinity of $550 million. So, as the 2024 budget was being crafted, there was an ample enough surplus to absorb these two policy measures, maintain and even expand other state programs, and still have ample reserves for contingencies.

Instead, lawmakers and the governor opted to spend the entire surplus in a single year, leaving a reserve insufficient to cover even a rounding error. And the spending wasn’t strategically targeted after debate and deliberation over priorities. Instead, each legislator was given tens of millions of dollars to spend on whatever he or she wanted. 

I blame the GOP leadership more than Hobbs for this. She was given the Hobson’s choice of either going along with it or seeing a government shutdown of an unpredictable duration. So, she went along with it, but the GOP leadership was the driving force behind the fiscal recklessness.

The state budget needs an ample reserve because unanticipated stuff happens over the course of a year. And, in this case, state revenues came in weaker than projected, throwing the FY 2024 budget into deficit. And yielding a yawning projected deficit for FY 2025, which began this month.

GOP leaders were crowing that the recently enacted budget resolved these deficits without resorting to gimmicks. I don't know what budgetary lexicon they were consulting, but that’s a crock.

There were some modest expenditure cuts enacted, and even some immodest ones. But the general fund deficits were largely papered over by sweeping roughly $750 million from other accounts. And that’s a gimmick.

In the political sphere, the term “state budget” usually refers exclusively to the general fund. But there is a lot of state spending that occurs outside of the general fund. The sweeps transferred money from nearly a hundred other accounts. This money was earmarked for other purposes. 

Sweeping other accounts to support general fund programs might be politically justified to resolve a deficit caused by exogenous factors, such as the bursting of the housing bubble. But not to resolve a deficit caused by a reckless spending spree. 

Regardless, fund sweeps don’t yield a sustainable state general fund budget. A sustainable budget is one in which same-year revenues cover same-year expenditures. These budgets flunk that test, bigly. 

As the dust settled in the FY 2024 budget, same-year expenditures exceeded same-year revenues by an eye-watering $2.6 billion. Around  15% of what was spent in FY 2024 was financed not by taxes collected that year, but by the carryforward surplus and the fund sweeps.

Things are better in the FY 2025 budget, but nowhere near being truly fiscally balanced. For FY 2025, same-year expenditures exceed anticipated tax collections that year by a still whopping $575 million. 

The projections for the subsequent two years, FY 2026 and 2027, show same-year revenues coming close to covering same-year expenditures. But that is an illusion.

The Legislature tries to create the impression of sustainability by calculating a thing called a structural balance, which compares ongoing revenues to ongoing expenses. What are labeled as “one-time” expenditures are excluded from this calculation.  

However, there are true one-time expenditures every year. For a truly sustainable state fisc, ongoing revenues have to cover both ongoing program expenditures and one-time expenditures for any particular year. 

Of late, the Legislature has also been mischaracterizing ongoing obligations as one-time expenditures, thus artificially improving the structural balance calculation. Perhaps the best illustration is building renewal grants for major renovations and repairs to schools.

In the 1990s, the state Supreme Court declared that the capital needs of schools was a state obligation. The state is currently being sued for inadequately funding them.

Yet the state budget treats the lion’s share of these building renewal grants, $183 million, as a one-time expenditure, even though school capital needs are perennial. Some projects will be completed every year, but others will need to be initiated.

The projections of nearly balanced budgets in FY 2026 and 2027 exclude this building renewal grant obligation and other expenses mischaracterized as one-time. If they were included, the projections for both years would be hundreds of millions of dollars in deficit.

Now, the future revenue projections are conservative and might be exceeded. In fact, the state ended FY 2024 with $400 million more in revenue than budgeted. 

That acknowledged, state finances are not being managed responsibly. And that should be a much bigger political issue than it is. 

Reach Robb at robtrobb@gmail.com.