State finances still on a shaky foundation

The FY 2027 budget is nothing to crow about.

The most important thing about the enacted state budget for next year isn’t what is in it and what got left out. Nor whether Gov. Hobbs or GOP legislators got the better of the negotiations.

Those are important things, substantively and politically. But the most important thing is how shaky of a foundation the budget is built on.

The state’s fiscal year begins in July and ends in June. Convention denotes each fiscal year by the calendar year in which it ends. Thus the budget for the fiscal year ending at the end of this month is Fiscal Year 2026. And the recently enacted budget is for Fiscal Year 2027.

The FY 2026 budget began with a carryforward surplus from FY 2025 of nearly $1.4 billion. For the general fund, the Legislature and governor sweep another $155 million from other state reserve accounts. However the projected surplus carrying forward into FY 2027 is just $773 million.

In other words, in the current fiscal year, state general fund spending will exceed what general fund taxes and fees will produce by roughly $750 million.

That’s a whopping current year deficit. But what was adopted for FY 2027 is even worse.

The FY2027 budget calls for spending $730 million more than that year’s taxes and fees are expected to produce. That drives the ending balance, or what could be considered a contingency fund, down to just $42 million.

That’s an inadequate contingency fund for an $18.3 billion enterprise. The state routinely has unanticipated expenses crop up during the course of the year in the tens of millions of dollars, even in the hundreds of millions. In Rumsfeld terms, this is a known unknown for which preparations should be made.

It gets even worse looking forward. The projected ending balance, or contingency fund, for FY 2028 is just $24 million, vanishingly small in a $18 billion budget. And even that’s suspect.

For future years, the projections from budget staff freeze all spending except that driven by statutory formulas, such as basic state aid to schools and Medicaid. In other words, for most of state government, no adjustments for inflation or population growth. And that’s after most departments experience a 2.5% reduction in FY 2027.

Additionally, spending labeled “one-time” isn’t continued in projections for future years. Some of this spending is truly “one-time”. However, completed “one-time” projects generally should be replaced by new “one-time” projects, if state government is to keep up with maintenance and technology.

Moreover, some of the spending labeled “one-time” really isn’t. The most obvious, and most consequential, is the grant program for major repair and renovation projects for district schools. In the 1990s, the state Supreme Court said that was an ongoing obligation of the state. A state district court judge has already found that the state has not kept up with this obligation.

For the last few budgets, around $180 million has been appropriated to this program. While the specific projects funded are “one-time”, the obligation isn’t. There will always be schools needing major repairs and renovations.

Yet the FY 2028 projection includes nary a cent for this ongoing obligation. Just including it would put the FY 2028 budget in deficit by more than $150 million.

Also labeled “one-time” and not included in the FY 2028 projection is $37 million for congregate care by the Department of Child Safety and $45 million in daycare subsidies. These aren’t “one-time” projects, such as a building renovation or technology upgrade. They are funding for ongoing state programs. Not continuing the funding doesn’t represent the completion of a “one-time” project. It would be a funding cut in ongoing state programs.

So, the state is spending annually, from the general fund, hundreds of millions of dollars more than general fund taxes and fees are producing. Most state programs have their budgets frozen or cut, with no better days on the horizon. The state enters FY 2027 with a hugely inadequate contingency fund and, ignoring the “one-time” fiction, is looking at a substantial deficit in FY 2028.

Now, the projections are based on modest increases in state revenues over time. Given existing economic conditions, that’s prudent. However, there is a chance that higher revenue growth would brighten this dim picture a bit, but probably not enough to render the shaky foundation solid and sustainable.

The picture was dimmed by the decision to fully conform state income taxes to the changes in the federal big, but not beautiful, reconciliation bill. However, Hobbs proposed to substantially conform in her own initial budget proposal. The difference between what Hobbs initially proposed and what was ultimately enacted also isn’t enough to render the shaky foundation solid and sustainable.

Besides, Hobbs is now trying to take political credit for the broader conformity GOP lawmakers insisted on, after having vetoed it when presented to her independently. A la John Kerry, in reverse, she was against broad conformity before she was for it.

I favored full conformity, as I did the income tax reductions that have been enacted over the years. However, as argued here, the state is really ripe for a thorough discussion and debate about the fiscal structure of state government. General fund finances have been unsteady for years, careening from huge surpluses to subsistence budgets, like the one enacted for FY 2027. And when there have been huge surpluses, they haven’t been husbanded to create a path to sustainability for ongoing state programs, including augmenting their budgets to keep up with inflation and population growth.

There are two paths to a solid and sustainable fiscal foundation for state government. Either enact some replacement revenue to partially offset four decades of tax-cutting. Or shrink state government to fit the existing revenue structure. Doing fewer things with programs that keep pace with technology, inflation, and population growth would be preferable to keeping most of state government on perpetual subsistence budgets.

Both Hobbs and GOP legislators are crowing about the FY 2027 budget. They managed to keep the lights on. But the shaky foundation they left unaddressed isn’t really anything to brag about.

Reach Robb at robtrobb@gmail.com.