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State and local government fiscal position in 1985.

State and Local Government Fiscal Position in 1985

THE surplus of State and local governments, as measured on a national income and product accounts (NIPA) basis, declined $5-1/2 billion in 1985 to $58-1/2 billion, following a $16 billion increase in 1984 (table 1). The decline, the first since 1980, was the net result of a $4-1/2 billion increase in the surplus of social insurance funds and a $10 billion decline in the other funds surplus--that is, in funds other than for social insurance programs. In 1984, the social insurance funds surplus increased $5-1/2 billion, and the other funds surplus increased $10-1/2 billion. The sharp decline in the other funds surplus in 1985 appears to reflect a strong increase in capital spending financed by borrowing rather than the beginning of a period of fiscal difficulties.

Receipts increased $35-1/2 billion in 1985, compared with $52 billion in 1984. The sharp deceleration was primarily accounted for by general own-source receipts (GOSR). Expenditures increased $41-1/2 billion, slightly more than in 1984. The acceleration was mostly in purchases of structures.


The 1985 increase in State and local government receipts was 6-1/2 percent, the smallest increase since 1982 (table 2). As already noted, the increase in 1985 was substantially below that in 1984 and was primarily due to a deceleration in GOSR. Federal grants-in-aid also increased less in 1985 than in 1984, and contibutions for social insurance increased about as much as in 1984.

GOSR increased 6-1/2 percent, and grants increased 5-1/2 percent, compared with 11-1/2 and 8-1/2 percent, respectively, in 1984. The slower increase in GOSR appears to reflect the state of the economy; real GNP increased about one-third as much in 1985 ad in 1984. Among the GOSR categories shown in table 2, the deceleration in 1985 was primarily due to smaller increases in personal income taxes and all major types of indirect business taxes and nontaxes, although corporate profits tax accurals, which declined after a strong increase, also contributed. The slower increase in grants reflected efforts by the Federal Government to reduce expenditures.

The net effect of legislative changes in 1985 was to reduce the increase in GOSR. For personal income taxes, legislative changes, many of which involved removal of temporary increases imposed in 1983 and 1984, contributed to the deceleration; in the absence of legislative changes, personal income taxes would have increased 10 percent. For sales taxes, legislative changes, most of which were increases, ameliorated the deceleration; in the absence of these changes, sales taxes would have increased about 6-1/2 percent.

The cuts in State personal income taxes in 1984 and 1985 brought the net effect of legislative changes since 1972 on the level of these taxes to approximately zero. There had been reductions in the middle 1970's, modest increases in the late 1970's, and sizable increases in the early 1980's. Legislative changes affecting State sales taxes have consistently driven receipts up since 1972; by the end of 1985, such actions cumulatively contributed more than $15 billion annually to receipts. About 60 percent of these additional receipts was from general sales taxes; another 20-25 percent was from motor fuel taxes.

The increase in contributions for social insurance, at 8 percent, was about the same as in the preceding 2 years but noticeably slower than the 12-percent average annual rate for 1969-82. A major factor in this difference was a slowdown in contributions to State- and local-administered retirement systems.

For 1969-82, contributions to these systems increased at an average annual rate of about 11 percent. These increases reflected the initiation by many underfunded public retirement systems of "special" contribution programs designed--usually over a period of years--to improve their actuarial condition. In the absence of such initiatives, steps to correct the underfunding could have been forced on them by the courts or by Federal legislation similar to that imposed on private pension plans in 1974 by the Employee Retirement Income Security Act.

Since 1982, the annual increases in contributions to the retirement systems averaged only 8 percent. It appears that many (but by no means all) of these systems had succeeded in significantly improving their condition. In addition, the slowdown in contributions may reflect two other factors. First, investment earnings for retirement systems in general have increased sharply since 1982. This stronger-than-expected growth caused some private pension funds either to recapture the amount of overfunding or to reduce contributions. At least four public retirement systems took similar steps during 1985. Second, some State governments were forced to reduce scheduled discretionary contributions because of fidscal difficulties in 1981-83. Those governments will be faced with making yet larger discretionary contributions at some future date.

Grants-in-aid increased for the third consecutive year, although the rate of increase decelerated in 1985. The $5-1/2 billion increase in 1985 was equally in highway grants and in public assistance (including medicaid) grants. Highway grants have increased substantially since 1982--over 40 percent--and have been a major factor in the increase in highway construction.


State and local government expenditures increased 8-1/2 percent in 1985, slightly more than in 1984, but much more than in 1982 and 1983 (table 3). The only major category of expenditures that accelerated in 1985 was purchases of goods and services. This acceleration was paced by purchases of structures, which increased 14 percent, compared with a 10-percent increase in 1984. Excluding structures, purchases increased 8 percent, compared with 8-1/2 percent in 1984.

The strong 1985 and 1984 increases in purchases of structures followed 3 years of declines. Highway construction accounted for $4-1/2 billion of the $6-1/2 billion 1985 increase, education and other public buildings for $2 billion, and sewer and water construction for about $1 billion. Congressional delays in passing the interstate cost estimate (see the January 1985 SURVEY OF CURRENT BUSINESS) apparently did not seriously impede regular funding for highway construction, but did inhibit use of funds generated by the motor fuel tax increase in 1984. For the four quarters preceding the passage of this legislation in early 1985, highway construction averaged around $20 billion at annual rates; for the last three quarters of 1985, it averaged around $25 billion at annual rates.

Compensation increased 7-1/2 percent in 1985, the same as in 1984; employment increased slightly in both years. In 1983, compensation had increased only 6-1/2 percent because employment declined. In the decade prior to 1983, compensation increases averaged about 10 percent. The deceleration since 1982 is in part due to the deceleration in contributions to retirement systems discussed earlier; wage and salary growth also slowed in 1984 and 1985. Purchases of other goods and services increased 8-1/2 percent, compared with 10-1/2 percent in 1984.

Although purchases of goods and services in current dollars accelerated in 1985, these purchases as measured in constant (1982) dollars decelerated slightly (table 4). In general, the difference reflects an acceleration in the prices paid by State and local governments; the fixed-weighted price index for these purchases increased 5.8 percent in 1985, compared with 5.4 percent in 1984. In constant dollars, all types of purchases increased, from less than 1 percent for compensation to 7 percent for structures.

Transfer payments to persons increased 6 percent in 1985, compared with 7-1/2 percent in 1984. The deceleration was accounted for by public assistance transfers, which increased only 4-1/2 percent after a 7-1/2-percent increase. Transfer payments for medical care, the largest component of public assistance, increased about 4-1/2 percent in 1985, down from 8-1/2 percent in 1984 and far slower than average increases of about 13 percent in 1981-83. In the recently completed comprehensive revision of the NIPA's, the treatment of these payments was changed to include them as transfer payments; previously, they were treated as purchases of goods and services (see discussion in the last section of this article). Efforts to contain cost increases in the Federally assisted medicaid program, which comprises most of medical care transfers, were a major factor in the deceleration.

In the net interest paid category, both interest paid and received increased less in 1985 than in 1984. The smaller increase in interest paid, 14 percent compared with 16 percent, largely reflected lower interest rates. The smaller increase in interest received reflected not only lower interest rates, but also a shift in asset holdings of social insurance funds toward equity holdings (with an accompanying large increase in dividends received). In 1981-83, State and local government retirement systems had shifted away from equity holdings and toward interest-bearing assets, which already comprised the bulk of retirement system investments. In 1984, after interest rates began to fall in 1983, this investment strategy was reversed.

Fiscal position

The State and local government sector, excluding the operatiosn of social insurance funds, recorded a surplus of $6 billion in 1985, $10 billion less than in 1984. This smaller surplus--the "other funds" surplus--appears primarily to reflect large increases in capital spending, which were largely financed by borrowing, and a slower rate of increase in receipts, which was, to some extent, due to legislative changes.

In 1983 and 1984, legislative changes increased taxes, and the resulting increases in receipts, coupled with moderate expenditures increases in 1983, resulted in a rapidly rising other funds surplus from the first quarter of 1983 into mid-1984 (chart 5). Expenditures increases began to accelerate in early 1984, but were still below the pace of receipts. Im mid-1984, when legislative changes began to hold down the increase in taxes and expenditures increased faster than receipts, the surplus declined. This decline has continued through the end of 1985, when the other funds measure was near zero.

Although the level of the other funds surplus measure in late 1985 is similar to that of late 1982, the implications for fiscal condition are not. At the end of 1982 ad in early 1983, many State and local governments had used up reserves accumulated during the late 1970's and were cutting back staff. Even construction spending was being cut despite widespread concerns about the need for major new investments in infrastructure. In 1983, governments increased taxes and severely limited expenditures increases in an effort to rebuild reserves. At the same time, the stronger economy boosted revenues (especially for States) more than expected. By 1984, revenues were strong enough to allow accelerated spending growth, especially for structures, and continued rebuilding of reserves. The drop down to approximate balance by the end of 1985 was primarily the result of continued spending growth and tax reductions.

It is always the case that these overall changes in the State and local sector in the NIPA's can mask important contrasts at different levels of government and in different geographic areas. The geographic factor was especially relevant for 1985 and will be for the near-term future. Source data do not support estimates for individual States in a NIPA framework, but scattered information suggests a major difference between the fiscal positions of States in the East, on the one hand, and those in the Midwest and Far West (probably excluding California), on the other. Neither farm States nor energy-rich States in the Southwest are sharing fully in the economic expansion that began in late 1982.


Several important uncertainties will confront State and local governments in the administration of their fiscal programs in 1986. Among the uncertainties are the pace of economic activity, the size and the composition of Federal expenditures, and the potential effect of Federal tax reform on State and local tax receipts.

If economic growth for 1986 remains around 2-1/2 percent, GOSR is unlikely to match the 1985 increase of 6-1/2 percent, unless legislative actions are taken to increase taxes. Federal grants are unlikely to exceed the level reached at the end of 1985. A number of proposals in the budget submitted in early February would affect grants--the creation of new block grants for local transportation and pollution control, a reduction in highway grants, a phasing out of grants for the construction of sewage treatment plants, and the elimination of the local revenue sharing payment for the third quarter of 1986--in a way that could result in a decline. If contributions continue to increase about 8 percent and if GOSR increases 6 percent, overall receipts will increase about 5-1/2 percent, compared with the 6-1/2-percent increase in 1985. If petroleum prices continue below $20 per barrel for much of 1986, the effect on State and local receipts at the national level may not be large, but in individual States in the Southwest, where severance taxes and oil and gas royalties are major revenue sources, the effect will be substantial.

The Federal tax reform now before Congress also would affect the State and local fiscal position. The House version of the legislation, in addition to reducing tax rates, increases the tax base by limiting or ending a number of existing deductions. Because most States define their own income tax base (corporate and personal) in terms of the Federal base, the result of the reform bill--in the short run at least--would be to raise the State tax base and, in the absence of rate reductions at the State level, to increase State taxes.

Expenditures should continue to increase in the range of 8-9 percent. The very strong borrowing for capital spending that helped to finance the 1985 increase in construction activity should generate a further increase in 1986, but it is unlikely that it will be as strong as in 1985. Compensation is likely to increase for two reasons: (1) There will be further small additions to employment; and (2) compensation for education employees will be under upward pressure as many States and localities try to improve their education programs. For other types of expenditures, the uncertainty with respect to economic activity over the next year is likely to hold down growth.

Overall, these changes would result in a NIPA surplus of around $50 billion, somewhat less than in 1985, and an other funds deficit of $5-$10 billion, the first deficit since 1982. The expected other funds deficit, like the declining surplus in 1985, reflects increases in debt-financed structures spending rather than fiscal stress. If the expected further increase in structures spending does not occur, then the other funds measure for 1986 will be in approximate balance.

Revised State and local government


The State and local government estimates used in this article reflect the results of the comprehensive revision of the NIPA's released in December 1985. All series are revised beginning in 1973, and many are also revised for earlier years. All constant-dollar series and price indexes are revised back to 1929 to reflect a shift in the base period from 1972 to 1982. The revised estimates reflect definitional and classificational changea and statistical changes. These changes are described in detail in the October and December 1985 issues of the SURVEY.

Two definitional and classificational changes affected State and local government purchases. The first change was the reclassification of medical vendor payments--that is, reimbursements by services under several programs, the largest of which is medicaid. In the revised estimates, these are treated as transfer payments to persons. Reimbursements to private providers, previously in government purchases of goods and services, are now included in persona consumption expenditures for medical services. Reimbursements to State and local hospitals are now classified as fees (nontaxes) included in personal tax and nontax payments. State and local purchases continue to include the wages and salaries and other expenses necessary to provide those medical services. The second change affected two other government assistance programs, which previously were split between purchases and transfers, based on whether payments were to individuals or vendors. In the revised estimates, payments made to energy suppliers on behalf of low-income persons and to vendors on behalf of crime victims, are now treated as transfer payments instead of purchases. The State and local surplus or deficit was not affected by either of the changes.

The major statistical change to the State and local government transactions was an improved estimate of highway construction in purchases of structures. The revised estimates, which are higher than previously published estimates, are based on data from the Federal Highway Administration's Highway Statistics. The previously published estimates were based on a Census Bureau series on the value of construction put in place. For 1982-84, the revised estimates also reflect the incorporation of new and revised data from regularly used sources usually incorporated at the time of annual July revisions of the NIPA's.

The comprehensive revision did not significantly affect the overall State and local government fiscal position prior to 1974. The surplus of the social insurance funds was unchanged from 1974 to 1982; from 1982 through 1984, it was revised up based on new source data from the Census Bureau. The other funds deficit was revised down from 1974 to 198o, largely reflecting the change in the data source for the estimates for highway construction. In 1984, the other funds surplus was revised up. For 1974-84, the average overall surplus was revised up by less than $1/2 billion; the average social insurance funds surplus was revised up $1-1/2 billion, and the average other funds surplus was revised down $1 billion.
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Author:Levin, David J.
Publication:Survey of Current Business
Date:Feb 1, 1986
Previous Article:Reducing the federal government deficit: an update.
Next Article:Plant and equipment expenditures by business for pollution abatement, revised estimates for 1973-83; estimates for 1984.

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