Virginia Knows How to Balance Its Budget

  • March 05, 2018
  • by Stephen Fehr

Pew Project: States' Fiscal Health

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When Virginians narrowly chose L. Douglas Wilder as governor in 1989, critics predicted that he would be a tax-and-spend Democrat. But Wilder, a grandson of slaves and a child of the Depression, ran Virginia with the conservative fiscal values his parents taught him growing up in a segregated neighborhood in Richmond.

“I was raised that you don’t borrow money from anyone, you don’t loan money to anyone, and you don’t spend what you don’t have,” says Wilder, now 86, who was the nation’s first elected African-American governor. 

L. Douglas Wilder

L. Douglas Wilder delivers his inaugural address in Richmond after being sworn as the governor of Virginia on Jan. 13, 1990. He went on to show how the state could become a model of bipartisan fiscal discipline. (Bettman/Getty Images)

Following those instincts, Wilder piloted Virginia through a recession without raising taxes, by cutting the size of government—“we had two student loan offices within 10 blocks of each other in Richmond; no one could explain why”—and by creating a savings account for budget emergencies. Working with the Legislature, Wilder showed how Virginia could become a model of bipartisan fiscal discipline.

That discipline worked to Virginia’s advantage 20 years later—when the Old Dominion, with its tradition of responding quickly to financial challenges, came out of the Great Recession of 2007-09 relatively quickly compared with many other states. In some states, the recession persisted after it had officially ended nationally. But while Virginia suffered its share of public employee layoffs, withdrawals from its rainy day fund, and deep cuts to services and programs—Governor Tim Kaine (D) slashed about $5 billion in spending between 2006 and 2010—its strong fiscal practices meant that it has managed most years to match revenue with spending. 

Sound budget management remains critical today, a decade after the Great Recession revealed short-sighted fiscal management in several states, because many states still face slow tax revenue growth, rising fixed costs such as Medicaid, and the risk of another downturn. 

The practices that helped Virginia weather the recession are at the core of a Pew project aimed at helping governors and legislative leaders emulate fiscally well-managed states. Pew’s state fiscal health team conducts research and provides technical assistance tailored to individual states that help lawmakers and other stakeholders understand and address long-term fiscal and economic challenges. On issues ranging from business tax incentives to managing revenue volatility, Pew researchers travel around the country offering evidence-based approaches. In 2018, for example, Pew staff will assist Georgia lawmakers in developing a process to evaluate the effectiveness of tax incentives, and will help Delaware officials clarify their rainy day fund withdrawals.

State legislators and executives who lack this kind of information often react to fiscal stresses by raising taxes and slashing services across the board instead of targeting the cuts based on performance of specific programs. They defer payments, especially to the public pension system, which in many states and cities is underfunded, and they spend one-time money for ongoing expenses or tax cuts that cannot be sustained. They drain their rainy day funds and, when the economy is growing, fail to rebuild them. Meantime, as costs rise every year, policymakers find it harder to align expected revenue with expenses over time, digging a hole so deep that it’s hard to recover. This lack of structural balance plagued Connecticut, Illinois, and Pennsylvania in particular as lawmakers tried to approve budgets in 2017. 

“Poor fiscal management makes government less effective for taxpayers,” says Michael D. Thompson, Pew’s vice president for state and local government performance. “Pew works with state officials to improve budget practices to promote long-term fiscal stability. We highlight states with best practices, such as Virginia, that are committed to putting in place evidence-based policies to ensure the stewardship of public dollars.”

Virginia’s adherence to cautious budget management is partially rooted in its history. Even before Southern states borrowed heavily to finance the Civil War, Virginia had piled up debt to build roads, canals, and railroads. By the time that Governor (and later U.S. Senator) Harry F. Byrd (D) was elected in 1925, paying off the debt was a heavy political lift. He was adamant that the state government balance its budget, keep taxes low, and pay for capital improvements out of available revenue instead of issuing debt. The budget was balanced by 1937.

The “pay-as-you-go” fiscal conservatism that he had championed began loosening in the 1960s, coincidentally around the same time that attitudes toward social issues—such as integrating the state’s public schools—also began to change. In 1968, Virginia voters approved the issuance of the state’s first general obligation bonds, while the U.S. Supreme Court ordered a Virginia county to accelerate integration of its schools. Twenty-one years later, Doug Wilder would be elected governor—a development as unthinkable in Harry Byrd’s era as the embracing of debt as a fiscal tool.

Wilder’s biggest contribution to modern-day Virginia’s fiscal management was changing the state’s constitution to require a rainy day fund to cover budget shortfalls and unexpected events. Pew has cited this reserve fund as a model for other states because it spells out when officials should deposit money into it and how much, tying those payments to the cyclical ups and downs of tax revenue. It also limits withdrawals, ensuring that money is available during recessions when it’s needed most. 

Since the Wilder administration, Virginians have elected three Republican and four Democratic governors; the state constitution bars the chief executive from seeking a consecutive term. The two parties have split control between the state House of Delegates and Senate at various times, though Republicans have held a majority in both chambers more years than Democrats have. But partisan advantage does not seem to matter as much in Virginia as it does in other states because of both parties’ allegiance to best fiscal practices. Even when Republican Governor James Gilmore proposed the largest tax cut in state history in 1998, a Legislature with split control phased it in and capped the amount of lost revenue.

What longtime Virginia political analyst Robert Holsworth calls the state’s “cultural commitment to fiscal responsibility under both parties” is aided by having one of the nation’s longest-tenured state budget experts, Secretary of Finance Richard D. “Ric” Brown, who emerged as Wilder’s top budget specialist in 1990 and has served under every governor and Legislature since. No one can determine Brown’s own party preference, and lawmakers and their staffs implicitly trust him to carry out their policy choices. “Virginia’s finances haven’t been looked at as a partisan thing,” says Brown, who retired in January.

Not every state can clone a respected official like Brown, but some do share Virginia’s culture of sound fiscal policy and informed management. One measure of a state’s financial standing is its bond rating, and 12 states hold top, or triple-A, ratings across the three credit rating agencies. (Virginia has been a triple-A state since 1938, which state officials say may be longer than any other state.) This top grade allows states to borrow at the lowest rates available, saving on interest costs and boosting the bonds’ appeal to investors.

“Whenever there is a question on the table about whether the bond rating could be affected by something, the General Assembly has responded,” Brown said. “Everyone is committed to that.”

At the heart of Virginia’s culture, as with other top states, is a dedication to aligning revenue with expenditures over several years, a concept called structural balance. States usually can tolerate cyclical deficits without jeopardizing their long-term fiscal health. But chronic shortfalls may indicate a more serious, unsustainable structural deficit in which revenue will continue to fall short of spending unless officials make policy changes. 

To ensure structurally balanced budgets, Virginia policymakers adjust the numbers as quickly as possible: Virginia is one of 17 states with a two-year budget. Some of the other 16 states leave a budget in place for two years, but Virginia amends its budget each of the two years, reflecting the ups and downs of revenue collection and demographic changes—such as the number of children, seniors, and Medicaid recipients—that can affect state programs. No state agency can incur a budget deficit at year’s end; otherwise the agency director is fired—and held personally liable for the full amount of the unauthorized deficit.

When spending needs to be trimmed, Virginia aims to make targeted, performance-based cuts instead of general, across-the-board cuts that can hurt essential services. With an accountability tool called Virginia Performs, policymakers look at the results that programs are getting to determine budget priorities. Pew has worked with other states to develop evidence-based practices to evaluate their programs, too, notably through the Pew-MacArthur Results First Initiative, which helps policymakers use cost-benefit analyses to understand the relative effectiveness of public programs.

In Virginia, three integrated fiscal reports promote long-term planning that addresses long-term risks and obligations. Governors are required to submit a six-year financial plan along with their budget proposals, which is consistent with how many businesses operate to stay ahead of potential problems. In addition to the financial plan, a six-year capital outlay plan lists current and new construction projects. Policymakers also prepare an annual report aligned with the capital plan and detailing the tax-supported debt and the projected debt service costs over 10 years, with an estimate of the maximum amount of new debt that the state could issue in the following two years.

Even well-managed states—which attempt to be proactive in responding to financial challenges—were thrown off course by the Great Recession’s precipitous fall in revenue. In Virginia, once revenue stabilized, policymakers decided to address increases in the state’s highest fixed cost: retirement benefits for public employees. Republican Governor Robert F. McDonnell and lawmakers reduced the pension system’s long-term liability by trimming benefits for new hires, increasing employee contributions, reducing the assumed rate of return on fund investments, and creating a hybrid 401(k) contribution/defined benefit plan.

Most states have some unique circumstances affecting their fiscal condition; Virginia’s finances are mercurial in part because of the extensive military, intelligence, and civilian presence of the federal government and the related technology sector. As the state’s largest jobs sector, government helps stabilize Virginia’s finances during downturns—but reliance on it also worsens already-volatile revenue when the federal government downsizes. Mandatory federal spending cuts that began in 2013 slowed economic growth in Virginia, costing thousands of jobs. 

Entering 2017, Virginia faced the possibility of additional mandatory federal spending cuts, repeal of the Affordable Care Act, and reductions proposed in President Donald Trump’s 2018 budget. To respond to the uncertain revenue loss those actions would create, a panel of economists, business leaders, and lawmakers lowered Virginia’s revenue forecasts, which led to additional restraint on spending. Pew’s research has found that states that revise their revenue estimates frequently are better positioned to manage volatile swings in tax collections. “This process has a natural conservative slant where adjustments are made to alleviate as much risk to the forecast as possible,” Governor Terry McAuliffe (D) noted in his end-of-the-year report to the Legislature’s budget committees. 

State officials also established a cash reserve fund in 2017 to help cover short-term revenue losses and to limit withdrawals from the state’s main rainy day fund. The second reserve fund and reduced revenue estimates were prompted in part by a warning from Standard & Poor’s Global Ratings in April 2017 that the state was drawing down its rainy day funds to balance its budget at a time when officials should have instead been depositing growing revenue into the rainy day account.

Now, the challenge of maintaining a structurally balanced budget will fall to Gov. McAuliffe’s Democratic successor, Ralph Northam, and a General Assembly with slim GOP majorities. Northam will not have much of a honeymoon: One immediate policy decision with fiscal implications is whether to expand Medicaid eligibility under the federal Affordable Care Act. He has picked Gov. McAuliffe’s transportation secretary, Aubrey Layne Jr., to replace Brown. 

Virginia is unique in barring governors from serving consecutive terms, which may contribute to the state’s financial well-being. Though critics say the term limit restricts a governor’s agenda and takes away voters’ ability to hold the chief executive accountable in the next election, the limit also forces a governor to stick within the two-year budget cycle he or she inherits upon taking office. 

No matter who is governor in the years ahead, Virginia faces challenges that will test its fiscal resolve. The number of Virginians 65 and older is growing four times faster than the state’s total population while the number of children under age 18 is increasing at a slower rate. Both trends will affect revenue and spending.

“We’re facing strong headwinds,” Delegate Chris Jones, the Republican chairman of the House Appropriations Committee, said following the Nov. 7 election that left the GOP-led Senate and House of Delegates narrowly divided. Del. Jones and other lawmakers stressed the need to uphold Virginia’s tradition of focusing on policy, not politics, in making fiscal decisions. “We can continue on the path of bipartisan cooperation or we can allow this committee to become a battleground for the next election.”