These states top the list of financial disasters

Puerto Rico may be getting all the attention lately as it looks to Congress for help after defaulting on much ^[1] of its May 2 debt payment of $422 million, but several states are grappling with their own fiscal disasters, for which there won't be any federal fix, only difficult choices.

"Do we pay for sick people in nursing homes, bondholders or pensions?" asked Donald Boyd, director of fiscal studies at the Rockefeller Institute of Government, a public policy research institute.

Illinois may be facing the biggest shortfall, but it has plenty of company. Among other states with yawning budget gaps and seemingly intractable competing needs are New Jersey, Kansas, Pennsylvania and Connecticut.

The overall situation is the worst in modern memory, according to Boyd. "Back in the 1930s, the economy was worse, but states didn't play the role then that they play now, where they finance education and Medicaid."

As most states begin their fiscal years July 1, the coming weeks bring intense negotiations to agree on budget plans to pay for schools, services, Medicaid and underfunded pension liabilities.

"Those are immediate problems," said Robert Inman, an economics and public policy professor at the Wharton School of the University of Pennsylvania. "The one to be ignored is probably pensions."

The problem of underfunded pensions has been several decades in the making, with estimates ranging from about a trillion-plus dollars to a couple of trillion, according to Boyd. "It's a big deal. When you spend money on higher pension contributions, you aren't delivering new services."

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In 37 states, pensions and Medicaid costs have grown faster than taxes over the last seven years or so, Boyd said of the widening gap.

And whether because of their political views, desire to get reelected or both, governors are typically reluctant to increase taxes in their states to cover any shortages.

"There is no popular way of raising revenue. Powerball is not going to bring in enough money to solve these problems," said Inman of the multistate lottery. "Not many governors are going to happily impose that additional (tax) burden on their residents. Only governors of some fiscal courage are going to step up to plate," added Inman of the option of increasing taxes.

Some states have fewer choices than others. The Illinois Supreme Court a year ago rejected the state's pension-reform law, ruling that lawmakers could not cut benefits for retirees and workers already in the system. It also told legislators they had to begin addressing the state's pension deficit, which exceeds $100 billion ^[2].

"Illinois is probably at or near the top of the list for deep fiscal stress among the states," said Boyd of the state with the nation's largest-unfunded public pension liability. Illinois has the economic capacity to pay its pensions, but "paying for a lot of services delivered in the past is, as it turns out, something voters don't like," said Boyd. "They could move to Indiana."

The Prairie State has been operating without ^[3] a budget since July, with Republican Governor Bruce Rauner and Democrats who control the State Legislature at loggerheads on a 2016 fiscal plan for 10 months. Rauner, a private equity investor serving his first term in elected office, has refused to negotiate without agreement on pieces of his pro-business, union-curbing agenda. Last week he signed a measure that includes $600 million in emergency funding to keep major universities running until September.

In preparing a not-yet-published report looking at the financing of state and local governments, Boyd and his colleagues found three major sources of fiscal stress around the country: Many, if not most states are contending with relatively slow tax revenue growth. "After you adjust for inflation and population growth, it's only a few percentage points above the start of the recession," Boyd said.

In addition, the cash generated by financial and real estate markets and funneled to states through capital gains has not recovered to prerecession levels, and Medicaid, the state-run program that helps low-income people with medical care costs, is consuming more state resources. "There's a lot of spending on Medicaid that you have to do. There are limited options for cutting Medicaid spending," Boyd explained.

He also counts New Jersey, Kansas, Pennsylvania and Connecticut as among the most fiscally challenged states.

States in the worst pension-related trouble "chose not to make contributions that actuaries requested," said Boyd. "Many of these states ignored it, or passed laws explaining why it's OK to stretch it over 50 to 70 years. Illinois, New Jersey and Pennsylvania fall into that camp, where years of underpayment exacerbate the problems."

New Jersey, which has an unfunded liability for its public-employee pension system of more than $40 billion ^[4], passed a law that put the state on a schedule of increased contributions, "but they fell off the ramp right away," said Boyd. "It remains to be seen how they are going to work it out."

In Kansas, the state government has struggled in the wake of moves in 2012 and 2013 to cut individual income tax rates and repeal an income tax on owners of 330,000 businesses.

Pushing the effort to gradually eliminate income taxes in the state is Governor Sam Brownback. He prefers to finance state government through increases in consumption taxes, which research released in January ^[5] found was driving residents across state lines to shop for groceries.

In Connecticut, lawmakers are in agreement not to raise taxes ^[6] as they strive to close a $960 million hole in the fiscal year that starts July 1. The state is considering temporary stopgaps that help balance the books in the short term but don't cut a projected deficit of about $2.25 billion in 2017-18.

Additionally, energy-producing states ^[7] are hurting in the wake of the sharp decline in oil prices. With Alaska facing its own budget shortfall, Governor Bill Walker is now calling for ^[8] the first state income tax in 35 years and for reducing the size of the annual check each resident gets for their share of oil revenue.