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Despite budget rebound, U.S. states see fiscal threats

By Lisa Lambert

WASHINGTON (Reuters) - Most U.S. states are set to end the current fiscal year in solid financial shape, but their recoveries could be derailed by an array of threats and increasing demands on their spending, according to a survey released on Thursday.

Bringing welcome relief after years of budget shortfalls, states' revenues have risen steadily over the last year. Many states are set to finish fiscal 2013 "with modest surpluses," according to a twice-yearly survey of state budgets by the National Governors Association and the National Association of State Budget Officers.

Still, spending remains below the levels reached before the 2007-09 recession and many states are constrained by obligations for health care and pensions. All states except Vermont must balance their budgets each fiscal year.

"There may be surpluses here and there that look good on paper," Dan Crippen, the executive director for the governor's group, said. "But the future is not very bright."

For most states, the fiscal 2013 year ends on June 30.

States will likely end this fiscal year with a combined balance of $23.7 billion, led by Florida and Indiana with balances likely of more than $2 billion. California, the poster-child of the states' fiscal crises, is expected to have a surplus of $785 million.

States also increased their rainy day funds this year to $39.52 billion from $34.23 billion in fiscal 2012. The ending surpluses and rainy day funds combined, known as "total balances," currently represent 8.3 percent of spending, meaning states have a sizeable amount on hand for emergencies.

But spending plans show a less rosy picture. Total state spending will likely increase 4.1 percent to $728 billion in fiscal 2014. That increase is smaller than the historical average of around 5 percent, and 19 states expect spending to remain below pre-recession highs, according to the report.

When adjusted for inflation, total spending is also below pre-recession levels. As a result, state governments' contributions to the tepid national recovery will remain small.

"It's really going to feel worse than those numbers suggest," said Don Boyd, a senior fellow at the Rockefeller Institute, which tracks state fiscal conditions. "More and more, revenue growth has to pay for things that aren't necessarily core and at the heart of what taxpayers and elected officials might want - in particular increasingly large Medicaid spending...and pensions."

The surpluses could also be the result of what Scott Pattison, executive director of the budget officers' group, called "a one-time only bump."

States' income tax collections were buoyed late last year as many taxpayers moved to act to ahead of the expiration of federal tax cuts. After that resulting burst of income, driven by taxes on capital gains, states could be in for a future revenue drop.

Many are using funds for one-time expenditures instead of "ongoing programs that will get them into trouble in the future," said Pattison.

In addition, the states' combined total balances masks some underlying weakness, as Alaska and Texas account for about half of that figure, noted Tom Kozlik, director and municipal credit analyst at Janney Capital Markets. States with low balances or rainy day funds would be vulnerable during another downturn, he said, adding that Illinois, New Jersey, Pennsylvania and Wisconsin, whose rainy day funds are all empty, would especially be at risk.

THREATS FROM THE FEDERAL GOVERNMENT

Many of the threats to state budgets come from the federal government, chiefly the across-the-board spending cuts known as sequestration that began in March. Because each federal agency is handling sequestration differently, no one can say how much state aid will fall.

"The cuts the federal government is implementing haven't rolled down to states yet and that is a bit of uncertainty," said Kil Huh, who directs state and local fiscal research at The Pew Charitable Trusts. "The cuts could be small but they could also hit aspects of the budgets pretty hard."

Meanwhile, Medicaid health insurance for the poor, which is reimbursed by the federal government and is states' largest expenditure, is set to expand under the "Obamacare" healthcare law.

The federal government will reimburse states 100 percent for people who qualify under the expansion, but states are nervous that those who are now eligible but not enrolled will decide to join amid the expansion. They will not receive the 100 percent reimbursement for those enrollees, and could be on the hook for millions of dollars, Crippen said. Medicaid enrollment already likely rose 3.2 percent in fiscal 2013, the report said.

Because two-thirds of Medicaid spending is for the elderly and disabled, Boyd said, costs will also rise as the Baby Boom generation ages.

(Reporting By Lisa Lambert; Editing by Tiziana Barghini, Cynthia Osterman and Leslie Adler)

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