Financial Squeeze May Pressure States Into Sweeping Budget Overhauls : Government: Officials are being forced to rethink which services they must deliver. Change won't come easily, experts say.


For as long as most people here can remember, Minnesota has prided itself on being one of the nation's most progressive states. A generous safety net of health and welfare programs protects citizens here from cradle to grave. There are dozens of well-kept state parks, and a state-supported college or vocational school within commuting distance for every Minnesotan.

"Many people view us as a socialist state," John Gunyou, the state's commissioner of finance, says with a chuckle.

But that historical largess is increasingly threatened by the fiscal squeeze that is choking state government these days. After wrangling with the Legislature last spring over how to avert a budget deficit, Gov. Arne Carlson has ordered state agencies to slash 5% from this year's levels before they even start putting together next year's budgets. And many here see even more stringent reductions over the longer haul.

St. Paul isn't the only state capital caught in such a squeeze. While all eyes are on California and its budget crisis, many other states are in serious financial trouble--and not just because of the recession. Ronald K. Snell, fiscal program director of the National Conference of State Legislatures in Denver, estimates that more than half the states are suffering from "structural" budget problems that will continue even if the economy improves.

Many states have been feeling the pinch since mid-1990. As a result, most of the easy cuts have already been made: slowing the growth of spending, changing budgetary accounting rules, raising "sin" taxes (on liquor, cigarettes and gambling), imposing user fees, forcing state employees to take unpaid administrative leave, selling off state-owned assets (such as buildings or other property) or borrowing from "rainy-day" cash reserves.

As a result, some fiscal experts such as Robert D. Ebel, who tracks state finances for Peat Marwick & Co., say governors and legislatures may soon be forced into what could prove to be the most sweeping restructuring of state government since the 1930s. The overhaul involves a full-scale rethinking of the basic role that states ought to play in today's society--including which services they ought to deliver and which they ought to cut.

"This is really unprecedented," said Brian Roherty, executive director of the National Assn. of State Budget Officers in Washington. "People are realizing that we're not going to be able to sustain the status quo any longer. We must restructure. We simply cannot afford a lot of the programs that we're doing right now."

If anything, state fiscal officers say, the budget crisis in California has prodded governors and legislatures to focus on their own problems more intently. "The debacle in California is sending a message to those who haven't been aware of the problem," Minnesota's Gunyou said. "There's been a big turnaround in thinking. People are realizing that it's in no one's interest to fall into what's happening in California."

Across the nation, state officials are responding to the crunch in a variety of ways.

Here in Minnesota, some half-dozen government commissions and civic groups are developing recommendations for a wholesale revamping of state services. The possibilities include reshuffling or consolidating some programs, restricting state subsidies to the genuinely needy, eliminating some services entirely and subjecting state agencies to competition from outside providers (such as allowing private groups to set up schools and receive the same per-pupil aid as public schools). In some cases, authorities may sell state programs to private firms, which would attempt to operate them for a profit.

Terry Bock, who serves as staff director for the Commission on Reform and Efficiency, the gubernatorial panel that has taken the lead in the long-term restructuring here, envisions a state government in the late 1990s that would look decidedly different from today's. The changes, he says, could affect everything from delivery of human services to education and environmental regulation. There will be more programs to serve the young and the elderly, Bock predicts, but cutbacks or consolidations in almost everything else.

The pressure for such sweeping revisions is a new experience for the states, which began expanding their roles and their services in the 1960s and continued to grow--despite cuts in federal aid monies--through most of the 1980s. There were periods of fiscal tightness, but they were mainly the result of temporary slowdowns in the economy, which crimped tax receipts and sent spending for social programs soaring. Once a recovery got under way--such as after the 1982-83 recession, for example--the fiscal health of states usually improved quickly.

But this time, the economic downturn isn't the only villain. As is the case with the federal government, formulas for "entitlement" programs such as Medicaid have locked states into spending more than their tax systems will be able to finance--even after the economy improves. Since state constitutions almost all prohibit budget deficits, the legislatures must either cut back or else raise taxes--which these days is politically verboten.

The situation has been exacerbated by the structure of many state tax systems, which are a hodgepodge of slapped-together measures that often make them particularly vulnerable to the economy.

Steven D. Gold, director of the Center for the Study of States at the Nelson A. Rockefeller Institute of Government in Albany, N.Y., says too many states rely on sales taxes, whose revenues tend to drop sharply whenever the economy slumps. Gold says restructuring the tax system may become a necessity in many states.

Demographics also play a role. Today's population is more heavily weighted toward school-age youngsters and the elderly, toward single-parent families and minority groups (particularly Asians and Latinos), than was the case even a decade ago. That means far higher spending on preschool education, child-care facilities, long-term care for the aged and a spate of basic social services.

Part of the reason that most states had been able to resolve their budget difficulties until recently is that they had been doing to counties and cities what the federal government did to the states during the early 1980s: shifting many of their responsibilities to lower-level jurisdictions while simultaneously cutting back sharply on aid.

In Minnesota, for example, local school operations are financed largely by the state, which has cut its education budget sharply. "It's the local areas that have been doing the restructuring," said Julia Friedman, a professor at St. Paul's Macalester College who has been following the trend.

Although some localities have managed to scrape through relatively unaffected, those that are heavily dependent on state aid have had to slash services. Little Falls, in central Minnesota, has had to cut its summer youth program, reduce opening hours at its park and museum and impose a citywide hiring freeze. Nearby St. Cloud is viewing the push toward longer-term restructuring with apprehension. "If they do what they've been talking about in St. Paul, we're in deep trouble," City Administrator Chris Hagelie said.

Not everyone agrees that restructuring is inevitable. Harold A. Hovey, editor of State Policy Reports, an Ohio-based newsletter that keeps tabs on state fiscal trends, argues there is "no way that you can document a serious structural deficit nationwide." California's situation, he says, "is unique"--because the budget shortfall is exacerbated by other factors, such as the cutback in defense spending. "There really is not a lot of activity" elsewhere, Hovey said.

The National Conference of State Legislatures' Snell agrees. Although he concedes that many states are being squeezed now--and are likely to face difficulties for the foreseeable future--he points out that whenever governors and legislatures finally get down to considering any serious restructuring, they inevitably run into a bevy of constituency groups trying to block them. Because of that, he says, "the results are always incremental."

And the Rockefeller Institute's Gold cautions that not all states have begun to come to grips with the problem. With the election just over the horizon, many key officials in state governments are still just marking time, he says.

"There are signs now that they are starting to ask questions, but it would be a mistake to give the impression that a lot of bold decisions are being made--or are actually being implemented," he said.

Indeed, the fiscal situation of the states varies widely from region to region. Idaho and Utah, both of which have been barely bruised by the recession, are in reasonably good shape. Illinois, Michigan, Pennsylvania, North Carolina and Connecticut are struggling to keep on top of the problem. And New York, New Jersey and California are hurting badly.

Still, fiscal experts say enough is going on behind the scenes to suggest that a widespread restructuring is in the offing. Iowa already has begun overhauling many of its state functions and is seriously considering consolidating some of its 99 counties and local school districts--at a potential savings of millions of dollars. Maryland has begun moving to privatize some of its schools. Florida has reformed its civil service system, and Michigan has reshaped its welfare system.

Minnesota has also begun revamping some programs. Last year, the state moved to close some of its mental health hospitals. It has consolidated its overlapping, three-tiered higher education system (universities, community colleges and vocational schools) into a single, presumably more efficient administration. And authorities here are pondering the possibility of merging some of the state's surfeit of counties and public school districts.

Bock's agenda at the Commission on Reform and Efficiency calls for looking into a wide range of options. The possibilities include reorganization of individual programs, overhaul of the state's antiquated budgeting and taxing procedures, reform of the 50-year-old civil service system and consolidation of the 23 separate departments and 200 boards and commissions that make up state government. Bock also hopes to devise plans for taking better advantage of computerization to streamline state operations and--hopefully--to lower costs.

But getting there won't be easy. State Sen. Gene Merriam, chairman of the Senate Finance Committee, cautions that every proposal for reducing the role of government is likely to run afoul of one group or another, from labor unions to parents (or sometimes children) of beneficiaries. "Every program you've got has got a constituency," he said.

And Merriam warns that the would-be reformers will have a tough selling job, both in the Legislature and among the electorate. "Not enough legislators or the public understand that (the fiscal problem) is not just a temporary phenomenon," he said. "There's kind of this belief that as soon as the recession is over and we have a recovery, things will be back to normal. But that just isn't so."

State Senate Majority Leader Roger Moe is more optimistic, predicting that after all the disenchantment with more halfhearted measures, Minnesotans may be ready to deal with the necessity for change.

"From what I can sense of politics, people no longer want politicians who aren't willing to confront the tough problems squarely," he said. "Folks realize that this can't go on. The decade of the '90s will see a reshuffling of the deck."

Admittedly, there's no guarantee that all of the reforms being considered will prove effective. Richard Keevey, New Jersey's secretary of finance, points out that "privatizing" state functions by contracting them out to private companies may help reduce costs slightly if the bidding is competitive. Even so, "it doesn't save a lot of money," he said. "It just means that you are paying someone else."

Some reforms are likely to require more spending, not less--at least at first--just to put them into effect. Minnesota, for example, recently enacted a major new health care program that all sides concede will require boosting current spending before its cost-containment provisions can begin to show any savings.

Despite the pain to local governments, the impact of the squeeze on states "hasn't been all bad," says Pam Wheelock, a former Minnesota state budget policy-maker who now is budget director for the city of St. Paul. "It does give us an opportunity to raise questions about closing some activities that would have been impossible to consider before."

To the Rockefeller Institute's Gold, much of what state governments offer in the 1990s and beyond may be shaped primarily by demographics. In recognition of the increasing prevalence of single-parent families, for example, Minnesota has begun experimenting with operating public school programs on the grounds of large corporations, so parents can be closer to their children. Authorities here also are considering setting up health and welfare offices in schools, so single parents can enjoy a form of "one-stop shopping" for human services programs.

But there will be trade-offs. Dorothy McCrung, Minnesota's tax commissioner, predicts that some traditional state offerings--such as tax incentives to persuade corporations to locate their factories in the state--will be eliminated in favor of more narrowly targeted grants or loans. "The growth that we saw in the '80s, many of us are never going to see again," she said.

The state's biggest job, says Gunyou, the finance commissioner, will be to dampen the expectations that Minnesota's citizens built up during the decades of progressive government.

"In good times we spent everything we had, and in bad times we raised taxes," Gunyou said. "It's caught up with us. We've sort of reached the limit."

Why States Are Going Broke

Here are the four biggest factors pushing state governments into the red: * Education: School costs are soaring. After a respite in the 1980s, enrollments are increasing again at an average of 1.5% a year. Education typically accounts for a third or more of state budgetary obligations and technology savings are minimal because labor costs--for teachers--remain the mainstay of the system.

* Medicaid: Soaring medical costs, along with with new federal requirements for broader coverage and increased paperwork, have sent Medicaid costs virtually out of control. The states' own costs for the program typically have been rising by about 20% a year. Other state health care costs also are on the rise.

* Prisons: Increased crime has prompted calls for more incarceration and fewer early prisoner releases. With more prisoners to house and feed, states' prison costs are soaring. Many state prison systems are already overcrowded, leading to construction costs to meet new demands.

* Aid to local governments: States provide major cash infusions to counties and cities, which use the money primarily for schools, highways and health care. After some cutbacks, states are having to turn on the spigot again to avoid forcing the localities to eliminate basic services--and face a voter backlash.

Sources: National Assn. of State Budget Officers, National Conference of State Legislatures, Nelson A. Rockefeller Institute of Government, Peat Marwick & Co.

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