States' bottom line improves, but can the good news last?

States' 2011 budgets are heading in the right direction as tax revenue increases, new indicators report. But with federal support waning and local demand on programs like Medicaid up, will the good news last?

This year, many states are receiving their first bit of good economic news since the beginning of the recession. More than half of them will take in more revenue than they expected, and a handful are reporting surpluses, according to one study. Several other reports point to the same trend: states' 2011 budgets heading in the right direction as tax collections increase.

Yet the reports come with a distinct "however." Stock market volatility could hit hardest those most responsible for rising tax revenues – corporations and the rich – and some states used budget-balancing gimmicks last year that they can't use again.

Moreover, states appear to be caught in the middle, with the federal government cutting the spending and stimulus that bolster state coffers, even as the rolls for caseload-driven programs like Medicaid are increasing. Adding to that pressure, localities will be looking to states for help as property taxes lag.

"Bottom line: State revenues are improving, but not enough to meet budget demands," says Corina Eckl, head of the fiscal affairs program of the National Conference of State Legislatures (NCSL). "It's like getting a 5 percent raise but finding out that your rent went up by 10 percent."

Still, any good news is welcome news for states.

•Tax collections exceeded expectations in at least 28 states, reports the Center on Budget and Policy Priorities (CBPP). In 23 states, the primary reason was "gains in income tax collections – a result of rapid increases in the incomes of wealthy individuals and corporations over the last year," a July 11 study states.

•The Nelson A. Rockefeller Institute of Government reported in July that "total state tax collections ... showed growth for the fifth consecutive quarter, following five straight quarters of decline." The numbers for the first quarter of 2011 were 9.3 percent better than the same quarter last year, it added.

•In March, NCSL noted that "state finances are showing encouraging signs of revenue stability," though it cautioned that "budget gaps remain a daunting obstacle for some states."

•The National Association of State Budget Officers concurred in its spring fiscal survey. "State fiscal conditions in fiscal 2011 are somewhat improved when compared to the difficult fiscal environment that states faced in fiscal 2009 and fiscal 2010," it said.

Among the states forecasting a surplus, however, there is little celebration.

Most of the surpluses are small compared with overall budgets, and many state budget officers are cautious in anticipation of serious fiscal challenges ahead.

Ohio wouldn't have a surplus at all if it weren't for $6 billion in federal stimulus money, which is ending, says Tim Keen, director of the state's Office of Budget and Management. Ohio has already earmarked the $246.9 million surplus – less than 1 percent on a budget of $27.8 billion – for a rainy day fund.

Nationwide, "so much of the growth in revenue will just replace federal dollars that go away," says John McGlennon, a political scientist at the College of William & Mary in Williamsburg, Va.

Indeed, the federal government is speaking only of cutting these days, making state budget officers nervous, because expenses for programs like Medicaid are going up. Arkansas, for instance, is looking at a 2011 surplus of $95 million thanks to federal stimulus. But looking forward, its Medicaid shortfalls alone are expected to reach $80 million in the next two years, says Brandon Sharp, administrator for the state Office of Budget.

States are also looking warily at their own local governments, which may need help because they are not seeing the same fiscal growth. Property taxes in many places are actually declining because of the bad housing market.

"The net effect here is that we are not really treating it like a surplus at all," says Jon Hanian, press secretary for Idaho Gov. C.L. "Butch" Otter, of what he calls the "$85 million surprise" on their budget of $2.3 billion.

"It is crucial to keep in mind that states are just beginning to emerge from a deep fiscal hole, and that recovery will be a slow process," says a June 17 CBPP report. "The economy remains weak, unemployment is still high, and state fiscal recovery tends to lag behind recovery in the broader economy."

For Indiana, however, a $1.2 billion surplus – roughly 9 percent of its budget – is more than a statistical anomaly. It is vindication for a budgetary discipline that preceded the recession, says Adam Horst, director of the Indiana State Budget Agency. He says state revenues exceeded their latest forecast by $204 million, and state agencies saved $181 million more than they had projected.

Most Indiana agencies have cut their budgets by about 25 percent since 2008. One result is that the number of full-time state employees is now below the 1976 level. Meanwhile, agency performance, which is measured and reported regularly, remains at some of the highest levels the state has ever seen, Mr. Horst says.

"While other states claim balanced budgets after delaying payments to schools and providers, skipping pension payments, or taking on additional debt, Indiana has an honestly balanced budget where annual revenues exceed annual expenditures, bills are paid on a timely basis, and pension obligations have been fully met," Horst adds.

Others agree that there can be "really good news" from the states' budget crises. "We need a real conversation about what kind of government we want and what scale of government we can afford," says Steven Beschloss, coauthor of "Adrift: Charting Our Course Back to a Great Nation." "And it's going to take smart, strategic thinking about what programs are most important and how states can spend their resources more wisely."