This is a background page about the legal requirements for state and local governments in the US to balance their budgets, and how this works in practice.
18 Jul 2010
It is often said that states are required to balance their budgets. Reality is more complex, and every state is different. Vermont has no requirement at all, and a few states require only that the governor's proposed budget be balanced. At the most rigorous end of the spectrum, some states have a constitutional prohibition against carrying a deficit forward and requirements that the governor propose, and the legislature pass, a balanced budget.
Generally speaking, it is the general fund operating budget that must be (more or less) balanced, with help from the rainy day fund and possibly some short-term borrowing (which might or might not be allowed to roll forward), but not usually long-term borrowing. Long-term debt to fund capital projects is considered to be outside the scope of balanced budget requirements.
It is difficult to generalize about how all this works out in practice. The only general accounting of state debt, from Census, does not reveal which debt is for capital projects, so it is impossible to tell to what extent states have built up debt from operating expenses.
There is very little general information on balanced budget requirements in the charters of local governments. Some state constitutions restrict municipal debt, some city charters restrict debt, and some cities apparently operate without restriction.
14 Mar 1881. State constitution, via the Indiana University Law School Web Team.
“ARTICLE 13. Political and Municipal Corporations; Section 1. Debt limitation”
“Section 1. No political or municipal corporation in this State shall ever become indebted, in any manner or for any purpose, to an amount, in the aggregate, exceeding two per centum on the value of the taxable property within such corporation, to be ascertained by the last assessment for State and county taxes, previous to the incurring of such indebtedness; and all bonds or obligations, in excess of such amount, given by such corporations, shall be void: Provided, That in time of war, foreign invasion, or other great public calamity, on petition of a majority of the property owners in number and value, within the limits of such corporation, the public authorities in their discretion, may incur obligation necessary for the public protection and defense to such amount as may be requested in such petition.”
May 1993. Paper from the UCLA CENTER FOR AMERICAN POLITICS AND PUBLIC POLICY
“State Responses to Fiscal Crises: The Effects of Budgetary Institutions & Politics. James M. Poterba”
“Unlike the federal government, most states are constitutionally prohibited from deficit finance over any prolonged period. … Most state constitutions prevent state governments from running deficits for any substantial length of time. Anti-deficit provisions take two forms: limitations on projected deficits, and limitations on actual deficits. In all but five states, the governor must submit a balanced budget. Thirty-nine states have constitutional or statutory provisions requiring the legislature to pass a balanced budget. After the budget has passed, however, revenues and expenditures may diverge from expectations and lead to an unexpected deficit. States vary in the speed with which they require such deficits to be eradicated. Only nine states allow actual deficits to be carried forward to the next fiscal year. Only six do not require the deficit to be eliminated in the following fiscal year. (Even states with explicit anti-deficit rules do run deficits. As noted below, borrowing is often defined as a way to close the “deficit.” This is why the national income accounts can show substantial state deficits, even though most states have anti-deficit rules.) States also vary in the policies that can be used to eliminate a deficit and satisfy the balanced-budget rules. In most states with no-deficit rules, borrowing can be used to close a current budget gap. Some states require such borrowing to be repaid in the next fiscal year, and prevent the use of long-term debt to cover deficits. Other states have constitutional limits requiring a referendum on new issues of long-term debt; this makes it relatively more costly to use debt to cover unexpected deficits.”
12 Apr 1999. NCSL paper under “Issues & Research”.
“State Balanced Budget Requirements: Executive Summary”
“All the states except Vermont have a legal requirement of a balanced budget. Some are constitutional, some are statutory, and some have been derived by judicial decision from constitutional provisions about state indebtedness that do not, on their face, call for a balanced budget. The General Accounting Office has commented that “some balanced budget requirements are based on interpretations of state constitutions and statutes rather than on an explicit statement that the state must have a balanced budget. …
There are three general kinds of state balanced budget requirements:
Such provisions can be either constitutional and statutory, but are more rigorous if they are constitutional since they are not subject to legislative amendment. Some states have two or all three of the possible balanced-budget requirements, and a few have only a statutory requirement that the governor submit a balanced budget. …
What has to be balanced? State balanced budget requirements in practice refer to operating budgets and not to capital budgets. Operating budgets include annual expenditures–such items as salaries and wages, aid to local governments, health and welfare benefits, and other expenditures that are repeated from year to year. State capital expenditure, mainly for land, highways, and buildings, is largely financed by debt. Court decisions and referendums on borrowing have led to the exclusion of expenditures funded by long-term debt from calculations whether a budget is balanced.
In practice, the following kinds of state revenues and expenditures also have little impact on state balanced budgets:
In each case, it is practically impossible for revenues and expenditures to get out of balance, since expenditures are controlled by available funds.
Thus it is not surprising that the focus of “balancing the budget” tends to be on the general fund although general fund expenditures compose only 50 percent to 60 percent of total state spending.
Enforcement of balanced budget requirements State requirements for balanced budgets do not impose legal penalties for failure to do so. There are, however, two sorts of enforcement mechanisms. Prohibitions against carrying deficits into the next fiscal year and restrictions on the issuance of state debt help to enforce balanced budget provisions by making it difficult to finance a deficit. In many states governors or joint legislative-executive commissions can revise budgets after they are enacted to bring them into balance.
Unlike the federal government, states are not able to issue debt routinely. Issues of general obligation debt require at least the approval of the legislature and in many states, voter approval. The issue of revenue bonds requires legislation to create an agency to issue bonds and the creation of a revenue stream to repay the debt. These practices mean that the issuance of debt is fully in the public view. It is extremely rare for a state government to borrow long-term funds to cover operating expenses, although. Louisiana did in 1988 and Connecticut did in 1991. There do not appear to be any other examples of this practice from recent years.
A legislature and governor can jointly revise a budget at any time. But most legislatures are not in session throughout the year, and some legislatures meet only for a few months every other year. Requiring legislative consent for every change in a budget would impose delays or the costs of special sessions. Therefore, many state constitutions allow governors or special commissions to revise budgets after they have been enacted to bring expenditures into line with revenues. …
Practice State balanced-budget rules are not as rigid as those recommended for the federal government in the early 1990s, which would have forbidden total expenditures above total revenues in any year and would have prohibited new borrowing. By this standard, states routinely run deficits because they borrow to finance capital expenditures. But this does not violate state balanced-budget requirements. Nor does rolling deficits in operating funds forward from one fiscal year to another, if a state constitution permits the practice.
Fiscal stress, however, can induce governors and legislators to adopt expedients so they can observe the letter, if not the spirit, of balanced budget requirements. Among these are sales of state assets, postponing payments to vendors, reducing payments to pension funds, borrowing from one state fund to finance expenditures from another, and “creative” accounting. Such expedients reflect the stress that can arise between legal demands for a balanced budget and political demands for the continuation of state programs without tax increases. The fact that such expedients tend to be limited to times of fiscal stress is in itself a measure of how seriously state elected officials take their responsibility to produce balanced budgets.”
Mar 2004. NCSL.
“State Balanced Budget Requirements: Provisions and Practice. Ronald K. Snell”
“in fact, state budgets generally are balanced, as annual reports from the National Conference of State Legislatures and the National Association of State Budget Officers show and as long-term statistical analysis has confirmed. …
These are examples of the constitutional requirements: Illinois:
The Governor shall prepare and submit to the General Assembly… a State budget for the ensuing fiscal year….Proposed expenditures shall not exceed funds estimated to be available for the fiscal year as shown in the budget. Missouri:
The governor shall, within thirty days after it convenes in each regular session, submit to the general assembly a budget for the ensuing appropriation period, containing the estimated available revenues of the state and a complete and itemized plan of proposed expenditures of the state and all its agencies, together with his recommendations of any laws necessary to provide revenues sufficient to meet the expenditures.
These examples make two important points about the requirement that governors' proposed budgets must be balanced: (1) the governor's recommendation depends on a revenue forecast that may or may not be accurate, and (2) in some states (if not in all) governors can balance their proposed budgets by recommending additional revenue sources or tax increases. For example, the budgets recommended by the governors of California and New York for fiscal year 1997 depended on the passage of favorable federal legislation to bring them into balance. Such issues are also involved in requirements that legislatures enact budgets that are balanced.
Prohibitions against carrying deficits into the next fiscal year are a way of enforcing the principle of a balanced budget, since without debt it would be impossible for expenditures to exceed revenues. At least 12 states lack a prohibition on resolving an end-of-year deficit by borrowing, as shown in table 1. A survey by the General Accounting Office found that 21 states may carry a budget deficit forward from one fiscal year (or biennium) to another “if necessary.”
The stringency of state requirements varies substantially. In 1984 the staff of the Advisory Commission on Intergovernmental Relations evaluated state balanced budget requirements on a scale of 0 to 10, with 10 indicating the most rigorous requirement. For a score of 10, a state had to have a constitutional prohibition against carrying a deficit forward and requirements that the governor propose and the legislature pass a balanced budget. Twenty-six states scored a 10, and 10 more states scored either eight or nine points. According to this evaluation, 36 (two-thirds) of the states had rigorous balanced budget requirements. The low-scoring states tend to have only a statutory or constitutional requirement that the governor submit a balanced budget, but not that one be enacted. Figure 1 shows the 26 highest-scoring states and the four with scores of 3 or less. In California, the voters approval of constitutional amendments in 2004 to require the legislature to enact a balanced budget and to prohibit borrowing to manage an end-of-year deficit moved California into the “most rigorous” category.
[Table 1 gives a summary by state of the particular form of balanced budget requirement.]
In the 49 states that have a balanced-budget requirement, legislators and governors focus on balancing the general fund budget without as much emphasis or concern for balance in the rest of or the entire the state budget. Why this is so can be explained with a review of the role that state general funds play in overall state finances.
State governments practice fund accounting, which means that all state revenues are designated to be deposited in a particular fund and that every item of expenditure comes from some particular fund. The practice has survived from the 19th century, when unified state budgets did not exist, and most revenues were earmarked for some specific expenditure.
The most important fund is the general fund, which in almost every state receives almost all tax and fee collections, interest income, and collections from minor or occasional sources (forfeitures, gifts, inheritances and the like), but not, as a rule, federal grants-in-aid. Most legislative appropriations are made from the general fund. The general fund budget is the focus of public attention to state budgeting, because the appropriations process is an element of the policy making process–at times, the dominant element. Balancing the general fund budget is what is commonly meant by balancing the state budget.
State general funds receive 50 percent to 60 percent or more of state revenue collections from all sources. Thus there are large amounts of money outside the general fund. In almost every state, federal funds are separate from general funds. Motor fuel tax collections in most states are deposited in a separate highway or transportation trust fund. It is not uncommon for other separate funds to exist, each with a specific source of revenue and specified purposes for which the revenue will be spent.
The general fund budget receives more attention than the rest of state budgeting in part because there are few annual decisions to make about the rest of the budget.
State governments usually plan to carry cash reserves from one fiscal period into the next. Whether the reserve is in a formal rainy day fund or not, it is intended to facilitate cash management and to make up possible shortfalls in revenue (the specifics vary greatly from state to state). Reserves are part of the annual equation, therefore. A state can have a balanced budget despite a revenue shortfall if reserves are available to make up the difference.
Restrictions on borrowing cause state governments to hold reserves to deal with revenue shortfalls and cash management issues that businesses would cover with short-term borrowing. Borrowing is not a routine matter for state governments. In some states, executive branch officials have limited authority to initiate short-term borrowing for cash-flow purposes, but in many states even short-term loans cannot be sought without legislative approval. In addition, only a few states can undertake long-term borrowing (for more than one year) without voter approval. The alternative is to maintain reserves.
Reserves are so important a part of state finance that both the National Conference of State Legislatures and the National Association of State Budget Officers measure them annually. Reserves measured as a percentage of state spending are the most useful simple measurement of state fiscal well-being. A reserve of 5 percent of budgeted expenditures is a conventional standard of adequacy, although what is appropriate for a specific state will depend on circumstances.
Capital expenditures …
Most state governments, unlike the federal government, have separate operating and capital budgets. Operating budgets rely upon continuing (annual) revenues. A growing amount of state capital finance comes from the issue of debt. It is extremely rare for a state government to borrow in the long term (for more than one year) for operations expenditures. …
Do state governments otherwise finance operations with long-term debt? There is no conclusive answer to that question, although it seems unlikely that the practice is extensive, even if there may be other examples than the two just mentioned. The only comprehensive time series of figures on state finance, the numbers published by the Bureau of the Census, do not offer enough detail to answer the question, and it does not appear that anyone has examined state annual financial statements for the answer. Two pieces of evidence argue that states do not use long-term debt to finance operating expenditures.
In recent years, states with intractable budget problems (like California) have found short term debt and rolling shortfalls forward from one year to the next to be enough to deal with the problem.
It is unlikely a state government could do so without proponents being attacked politically for unsound fiscal practices. Unlike the federal government, state governments do not have the luxury of borrowing money routinely and quietly. …
For the majority of states, however, the most important factor contributing to balanced budgets is not an enforcement mechanism or a provision specifying how a shortfall will be resolved. Rather it is the tradition of balancing the budget, which has created a forceful political rule that the budget will be balanced. Although states with enforcement provisions emphasize their importance, the expectation that state budgets will be balanced is the most important force in maintaining a balanced budget.”
[A number of sources are given, if one wants to pursue the topic further.]
[Includes a link to an appendix that gives the actual wording of the requirements in each state.]
Undated; accessed 18 Jul 2010. San Francisco Charter.
“SEC. 9.106. - GENERAL OBLIGATION BONDS”
“The Board of Supervisors is hereby authorized to provide for the issuance of general obligation bonds in accordance with the Constitution of the State of California. General obligation bonds may be issued and sold in accordance with state law or any local procedure adopted by ordinance. There shall be a limit on outstanding general obligation bond indebtedness of three percent of the assessed value of all taxable real and personal property, located within the City and County.”
Undated; accessed 18 Jul 2010. San Diego study on effect of balanced budget requirements.
“Subcommittee on Financial Reform: Staff report on cities with balanced budget requirements by James Ingram”
“Cities with charters not expressly requiring balanced budgets: Detroit, Columbus, Boston, Cleveland”
[Detroit has many problems besides its charter; still, it is interesting that the first city listed here is probably facing bankruptcy.]