Delaware should be stress-testing its budget, suggests new Pew report

When Delaware’s fiscal year starts in April, it won’t be facing a deficit like some other states, but with federal pandemic emergency funds expected to run out, next year may bring significant budgetary challenges. A new report offers tools governments can use to help navigate the rocky waters ahead.

Gov. John Carney won’t be captaining Delaware’s ship at that point, as he’s term-limited, but when he gave his final State of the State address last week, the budget was the main topic — and he predicted future challenges.

One factor he called out: State healthcare costs have gone through the roof.

“This year, between Medicaid and our insurance plan for state employees and retirees, we’re spending nearly $2 billion on healthcare alone,” Carney said. “That’s roughly $200 million more than our costs last year. The state’s share of Medicaid alone costs $1 billion. Those are jaw-dropping numbers.”

The governor issued a warning. “If we don’t get serious,” he said, “healthcare spending will crowd out other investments.”

How does a state “get serious?” The independent public policy nonprofit Pew Charitable Trusts recently released Tools for Sustainable State Budgeting, which offers two analytical methods states can use for long-term sustainability:

• A long-term budget assessment
• A budget stress test

Many of the critical services a state government provides — including healthcare, education and public safety — won’t change that much in 5, 10 or even 20 years, the report notes. Yet many states don’t have long-term plans.

“It’s really important that we’ll be able to afford all these things, not just now but in the future,” Josh Goodman, senior officer of state fiscal health for Pew Charitable Trust, told Technical.y. “States typically focus more on their annual or biannual budgets.”

Though Delaware does not currently use these specific tools, it does have some of the components through its Delaware Economic and Financial Advisory Council (DEFAC), a body appointed by the governor that advises on things like revenue forecasts.

However, Goodman said, while DEFAC does put out long-term revenue and expenditure forecasts, it doesn’t formally compare those numbers, which is a big part of the recommended long-term budget assessment process.

Figuring out what the numbers mean

How do the tools work?

A long-term budget assessment is a projection of revenue and spending at least three years into the future, and then looks at why the balance sheet ends up where it does.

If a surplus is projected, for example, assessors might work to figure out where it could be invested to bring the most good. If there’s a deficit, policymakers could figure out what factors are leading to it and where they might adjust before situations reach crisis levels.

“If the state is projected to spend more revenue than it brings in … why is that?” said Pew’s Goodman. “Is it because there’s a particular category of spending that’s growing quickly? Is it because a revenue source the state used to have access to is in decline? Getting at those factors can help the state figure out what the numbers mean.”

A long-term budget assessment makes predictions based on normal, expected conditions. As we all know well, things don’t always happen that way, which is where the second tool comes in.

“A budget stress test says, ‘What if we have a problem?’” Goodman explained. He posed the case of a potential recession, which could affect different states in different ways.

“In Delaware there’s no state sales tax,” he said, “and with its tax on personal income, if fewer people are employed, or if their wages go down, they pay less in income taxes,” leading to less in the coffers at the same time as demands on state benefits like Medicaid and SNAP would likely increase.

Generally, states save in good years for use in these down years. A stress test analyzes how large state deficits would be under hypothetical recessions, from mild to severe, and what kind of tools or what size reserves the state must have to balance that future budget without cutting services people need most or raising taxes on struggling businesses.

Delaware as a perfect candidate for these tools

Stress testing could be an especially important practice for Delaware, according to Goodman.

“For one, the state has an unusually volatile tax code,” he said, referencing the lack of a statewide sales tax. “[Pew] puts out estimates of tax revenue volatility by state. Delaware is in the top 10.”

As a result, Delaware’s highs might be higher than average, and its lows might be lower.

“They really need to be thinking about saving the right amount of money during those highs for use in the lows,” Goodman said. “Delaware’s a state where there’s been this kind of ongoing conversation about reserve levels and reserve policy, so the state has a formal rainy day fund.”

According to Pew’s research, so far only 15 states use long-term budget assessments and 13 use budget stress tests. Eight states use both.

“There are states that have used them and made really important policy decisions,” Goodman said. He cited Montana, which conducted stress tests that showed its monetary reserves weren’t large enough. “So they put more money aside in their rainy day fund.”

Delaware may be well-positioned to adopt the analyses, he added.

“If you read the governor’s budget proposal this year, there’s a lot of talk in there about long-term sustainability,” Goodman said. “And it goes back actually years in the state, with the creation of that additional reserve fund. … There’s definitely been thought in the state of getting beyond the short term picture and making sure over the long term the state is on a sustainable path.”