SPEED READ:

State revenues are rising, largely because of the strong economy and federal tax reform.
A total of 40 states beat their revenue projections in fiscal 2018, the highest number to do so since 2006, according to a survey by the National Association of State Budget Officers.
As a result, states increased their total spending by 4.3 percent to $874.6 billion in fiscal 2019.

A year ago, state budget directors were pumping the breaks on spending amid uncertainty over the economy and how the federal tax overhaul would hit state finances. But after 12 months of revenue growth that has surpassed just about anyone’s expectations, states are planning on some of the biggest spending increases since before the Great Recession.

A total of 40 states beat their revenue projections in fiscal 2018, the highest number to do so since 2006, according to a survey released this week by the National Association of State Budget Officers (NASBO). As a result, states bumped up their total spending by 4.3 percent to $874.6 billion in fiscal 2019.

The spending growth may ultimately be higher than that when all is said and done. Just halfway through fiscal 2019, a total of 19 states are now reporting that revenues are coming in above target. It’s a big turnaround from the past two years, which saw at least as many states report having tocut spending by the midway point of the fiscal year. (Just seven states are reporting doing so this year, and the cuts are minimal.)

Why State Revenues Are Rising

John Hicks, NASBO’s executive director, says most of the growth states are seeing is from income tax revenues, which increased by nearly 8 percent in fiscal 2018 over the prior year. Sales tax revenues also had one of the strongest years in recent memory, growing by 4.2 percent. The growth is being attributed to a strong economy, as well as high earners opting to file their income taxes early in response to some of the changes enacted in last December's federal tax overhaul.

Still, Hicks cautions, the growth is moderate by historical standards. For instance, when inflation is taken into account, this year’s spending total falls just below the total spending in 2008.

What's more, he adds, “states to varying degrees are facing long-term spending pressures ranging from health care and pensions to adequately funding K-12 education and infrastructure.”

So what are states spending this boon on?

Rainy Day Savings

Savings are a big priority. Last year, states put a lot of their surplus into rainy day funds, which boosted those totals from 5.3 percent of general fund spending to 6.4 percent. They’re continuing that trend in fiscal 2019, with rainy day funds expected to total an amount equivalent to 7.3 percent of operating budgets. That’s far more savings than in 2008, when states had under 5 percent of their annual operating costs stowed away.

That attention to savings is one reason that the category of “all other” spending is registering the largest year-over-year increase of any other spending category.

Another reason is that states are funneling an additional $16.3 billion into this all-encompassing category to attend to one-time expenses.

For example, Colorado and Kentucky are putting a half-billion combined in additional pension payments. California is budgeting $1 billion for wildfire response and cleanup following yet another devastating forest fire season this fall.

Education Funding

After a volatile spring with teacher protests, K-12 education funding in fiscal 2019 is also seeing the second-largest total increase in funding. Lawmakers are putting an additional $11 billion in that category.

In addition to states that saw walkouts such as Oklahoma, Arizona and West Virginia, 10 states have devoted at least 40 percent of their 2019 spending increases to K-12 education. They are Alabama, Idaho, Georgia, Kansas, Minnesota, Missouri, New Jersey, Pennsylvania, Virginia and Washington.

Looking ahead, states expect their biggest revenue boost to come from their corporate income tax, which is expected to increase by more than $2 billion across the 50 states this year thanks to the expected growth in the economy.That’s a far cry from a couple years ago when corporate income tax revenues were on the decline.

Meanwhile, states aren’t expecting as much of an impact in fiscal 2020 from income tax revenues. That’s because 16 states have enacted income tax cuts to counteract changes made under the federal tax overhaul that would have resulted in a state tax hike for residents.

In other public finance news this week:

Kentucky Pension Law Overturned

The Kentucky Supreme Court delivered a blow to Republican Gov. Matt Bevin and GOP lawmakers on Thursday when it struck down a pension reform law hastily passed in the waning days of the legislative session.

The ruling was a win for Democratic Attorney General Andy Beshear, and it puts a stop to planned benefits cuts for public employees, including ending traditional pensions for newly hired school teachers.

In a unanimous decision, the court agreed with Beshear that the pension reform was not given the constitutionally required three public readings in the Senate and House chambers. Lawmakers had converted a sewage treatment bill into a pension bill, and then rushed it through in a matter of hours with no public review.

The decision was hailed by unions and retirees who called it a win for transparency. But the issue is far from resolved. Bevin and others have said that nothing short of an overhaul is needed for Kentucky’s pension systems, which have some of the nation’s highest unfunded liabilities.

Pot Gets the Green Light at CalPERS

More than a decade after the California Public Employees’ Retirement System dumped its tobacco stocks out of principle and public health concerns – a move that ultimately cost billions – the country’s largest pension system is getting back into the smoking game. Sort of.

A story by Barron’s this week revels that CalPERS now holds a small position in Tilray stock (TLRY), a Canadian maker of cannabis for medical and recreational adult use. When pressed to justify the distinction, a spokeswoman for CalPERs told the publication that, while the board may make divestment decisions it does not dictate buying responsibilities. That falls under the purview of the investment office.

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